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Real Estate Competition - Campus Finalist

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Oscar Haman

Based on the 4th annual Cornell International Real Estate Competition. A potential recommendation for a buy or pass of mezzanine debts Completing this case involved: - Using the lien on a mezzanine debt in order to take equity interest of the owner's properties - Computing an amortisation schedule in order to determine the financial capabilities of the owner - Analysing the post GFC conditions of the U.S economy and real estate market - Conducting a DCF to determine exit selling price of the properties - Providing relevant renovations to the properties in order to main standard of Class A classification

Economy & Finance
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11 1 AN ACQUISTION OF THE PORTFOLIO 1
2 Table of Contents 2 2 Strategic Overview3 5 6 7 9 10 11 National Market Overview Portfolio Summary West Loop Summary Cutler Centre San Diego Summary Rivers Tower Los Angeles Summary12 13 14 15 16 17 18 Bryant Plaza Portfolio Recap Valuation Valuation of Debt Valuation of Property Assumptions Recommendations19 20 21 22 23 24 25 Strategic Summary Due Diligence Acquisition of the Loans Debt - Equity Refinancing Renovations Cutler Centre - Upgrades26 27 28 29 30 31 32 Rivers Towers - Upgrade Bryant Plaza - Upgrade Exit & Sale Risk Recap Overview & Summary Expected Returns33 35 36 57 83 93 Appendix Division 1 – Market Research Division 2 – Strategic Research Division 3 - Risk Division 4 - Valuation Summary34
33 After conducting appropriate negotiations and due diligence, we should move to purchase the portfolio at a 75% discount to it’s face value. We should leverage our lein against the borrowers equity and our capacity to limit investor losses to convert out mezzanine loans to a proprietary interest in the properties We should renovate all three properties to maintain the Class A classification of the properties. We are pursuing a minimum multiple on equity of 2.5x. Our model indicates that the portfolio will return a levered IRR of 22.28% and a levered equity multiple of 4.11x This exceeds the needs of Sun Rock Capital’s fund. Expected Returns Strategic Overview SWAPACQUIRE RENNOVATE 3 We believe that we will be in the end of a strong bull real estate market in 2018. Thus, we should sell them SELL The current downturn in global real estate market conditions creates the opportunity for us to purchase quality Real Estate assets at a substantial objective discount. Investment Thesis 3 We recommend pursuing loan-to-own strategy consistent with the funds targeted returns and overall strategy
44 4 PORTFOLIO & MARKET OVERVIEW – BUILDING AN ECONOMIC NARRATIVE 4
5 • GFC-driven Yield spikes appear to have ended • Research into the principles of mean reversion suggest yield will compress slowly over the coming decade Expected Growth Rates Yield Trends US Property Market Overview • The recent decline in global market conditions has caused a substantial shift in the commercial real estate industry • Interest rates are at all an time low – 0.25% • Commercial prices are currently sitting at 2002- 2003 prices. • The current interest rate environment is expected to cause a gradual decrease in yields over the coming 5-10 years 0.0 20.0 40.0 60.0 80.0 100.0 120.0 1997-12-01 1999-12-01 2001-12-01 2003-12-01 2005-12-01 2007-12-01 2009-12-01 Green Streets - Commercial Property Price Index • Investors expect rent to grow at an increasing pace • In the short term, it appears that rent growth will be outstripped by expense growth and inflation 0.00 2.00 4.00 6.00 8.00 10.00 12.00 14.00 US Delinquency Rates • Loan Delinquency rates appear to have peaked mid- 2009 • We expect rates to decrease slowly in line with current interest rate conditions Our analysis indicates that equity offers better long-term risk adjusted returns than debt 5
6 A portfolio in context… • The fund has diversified its holdings well across major American cities • This limits our exposure to localised disaster and regional economic volatility Geographic Diversity The global financial crisis has forced us to target a minimum MOI of 2.5x • 67% of used capital has been deployed to purchase equity • Current market conditions imply that a weighting towards equity is best practice Investment Vehicle Office 52% Industrial 13% Hotel 16% Retail 19% • Office buildings are less sensitive to macroeconomic conditions than retail or hotels • This allows them to act as a relative hedge to current financial volatility Building Kind • 4 properties are expected to make a loss • This means that, in order to meet the portfolio target MOI of 2x, the remaining capital must be invested at at least 2.5x Projected MOI 67% Capital In Equity 1 3 1 3 1 2 1 <0.5 <1 <1.5 <2 <2.5 <3 <3.5
7 • West Loop is a former industrial center that has experienced a significant degree of urban gentrification • It’s central geographic position creates an opportunity for high reach retail businesses such as bars and restaurants • The decline of many of Chicago’s outer suburbs creates substantive demand for high-wealth, developed inner-city property West Loop West Loop – A growth centre… The West Loop submarket is a substantial growth pocket that persists despite Chicago’s poor economic performance 4000000 4100000 4200000 4300000 4400000 4500000 4600000 4700000 4800000 Chicago Historical and Projected Unemployment Data - 2007-2011 Consumer 17% Services 28% Manufacturin g 14% Construction 41% Chicago Industry 1641 935 855 730 622 520 494 487 New York LA Chicago DC Dallas Atlanta Houston San… Business Service Employers (‘000)
8 Copernicus Landsat 1984 West Loop - Growth and Development Trends Copernicus Landsat 2010 We believe the fundamental geographic characteristics of the West Loop submarket will drive intrinsic demand growth. A comparison of satellite imagery shows that the developmental boundaries of Chicago have expanded 200-300% over the past 25 years. This city growth is a strong driver of demand for centralised real estate assets.
9 5400000 5600000 5800000 6000000 6200000 6400000 6600000 6800000 7000000 7200000 2011 2012 2013 2014 2015 2016 2017 2018 W Location: West Loop Cutler Centre • Cutler Centre is a 15-storey Class A office tower located in the West Loop submarket of Chicago. • 240,000 square feet of office space consisting of well-diversified mix of tenants. – 82% occupancy rate in office – Currently in line with market, but was below- market last year • 10,000 square feet of street-level retail space consisting of the Bank of America, convenience store, and clothing boutique. – 100% occupancy rate – Entire rental contract rolls over in 2018 • Rent roll unknown • Loan structure consists of a senior loan and two mezzanines Property Overview SUMMARY Cutler Towers can act as a lever to access growth in the growing West Loop submarket NOI Projections
10 • San Diego has been considered a leading area to launch a company • San Diego is enclosed by the Laguna Mountain Range. This creates a premium for downtown real estate. • San Diego has been designated a Foreign Trade Zone. This creates opportunities to leverage global trade trends • Property sales reached an all time low of 2,142 in January 2008 • Currently, sales sit at around 3000 – substantially lower than the historical mean of 4,000-4,500 • Auction success rates are at an all time low Downtown San Diego Downtown San Diego – Dense development San Diego Property Sales 2000-10 0% 20% 40% 60% 80% 100% 120% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Auction Success Rates 2000-10 We can capitalize on poor market conditions to ride San Diego’s growing technology and trade industries
11 6400000 6600000 6800000 7000000 7200000 7400000 7600000 7800000 8000000 2011 2012 2013 2014 2015 2016 2017 2018 W Location: Downtown San Diego Rivers Tower • Rivers tower is a 20-storey Class A office tower located in the San Diego CBD. • 500,000 square foot of office space consisting of a diversified tenant mix – 75% occupancy rate – Below-market • No major capex has been invested and no major renovations have been made • Rent roll unknown • Loan structure consists of a senior loan and two mezzanines Property Overview SUMMARY Rivers Tower will give us access to the Downtown San Diego submarket NOI Projections
12 • The Los Angeles Property Market appears to have bottomed out • Trade volumes, a major driver of LA economic activity, are at 2003 levels • Commercial yields have fallen by over 2% over the past two years • There has been a substantial drop in the volume of Real Estate transactions across the city • This indicates that liquidity has dried up substantially over the past 1-2 years • We can leverage this in our debt- equity swap • This will also allow us to ride the inevitable economic recovery Downtown Los Angeles Los Angeles – Leveraging a global trade fulcrum 0 2 4 6 8 10 12 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Volume(MillionTEU) Port of Los Angeles Trade Volumes - 1990-2020 Poor Real Estate performance creates an opportunity to capture recovery-linked growth Los Angeles Commercial Yields Sales Volume
13 3700000 3800000 3900000 4000000 4100000 4200000 4300000 4400000 4500000 4600000 4700000 2011 2012 2013 2014 2015 2016 2017 2018 W Location: Downtown San Diego Bryant Plaza • Bryant Plaza is a 15-storey Class A office tower located in downtown Los Angeles. The building enjoys excellent visibility and contains 300 on-site parking spaces. • 275,000 square foot of office space occupied by varied tenant groups – 75% occupancy rate – Below-market • Building has undergone a significant renovation in 2000. • Loan structure consists of a senior loan and a mezzanine loan Property Overview SUMMARY Bryant Plaza will give us access to the Downtown Los Angeles submarket NOI Projections
14 • Real Estate market cycles typical cycle over between 7-11 years • The last cycle ended in 2008-2009 • The portfolio could act as a vehicle to leverage this trend Fitting the portfolio together… Economic Recovery Market Cycles MARKETS West Loop Increasing Rent & Yields If purchase at the right price, the Portfolio may allow us to ride and profit from a global economic recovery San Diego Increasing Rent & Yields Los Angeles Increasing Rent & Yields US Property Market Cycles
1515 15 VALUATION – QUANTIFYING VALUE 15
16 W Valuation of the portfolio: Debt Instruments We should purchase the debt instruments at a 75% discount to their implied value Rivers Tower $30,851,197 Discount: 70.00% Purchase Price: $9,255,359 Cutler Centre $20,776,748 Discount: 70.00% Purchase Price: $6,233,024 Bryant Plaza $55,334,228 Discount: 90.00% Purchase Price: $5,533,423
17 W Valuation of the portfolio: Underlying Properties Performing a debt to equity swap would allow us to access the underlying value of these properties
18 CAPITALISATION RATESGROWTH RATESDiscount Rate 9 9 9We have calculated a 9.85% discount rate Our rental growth rates are predicted to grow 2-3% p.a. We predict a 0.4% decline in cap rates per year, leading to an exit cap rate of 5.55% Assumptions Discount Rate Assumptions: Loan Start Date: 01-June-2007 Loan End Date 01-June-2012 Discount Rate: 9.85% 10 Year US Treasury Rate: 3.85% Real Estate Risk Premium: 6.00% Rental Growth Rates Assumptions: Cutler Center 1.2% Post-Capex 3% Rivers Tower 2% Rivers Tower Post Capex 3.85% Bryant Plaza 2% Bryant Plaza Post Capex 3% as the CRE equivalent of the price/earnings ratio in the stock market (see Campbell and Shiller 1988 for the pricing implications of these valuation measures). According to theory, this rent/price ratio is largely a function of interest rates and expected increases in the property’s price. Consider someone who wants to use a real estate property for one year. This person can get the space in two ways. He or she could rent the property for the year, which would cost a year of rent. The rent would appear as part of the property owner’s net operating income. Alternatively, the person who wants to use the property could borrow money, buy it, and hold it for a year. The cost of this ownership option, referred to as the user cost, consists of interest payments on the purchase loan plus the expected change in the property’s price over the holding period. In a well-functioning market with zero transactions costs, the price of these two alternatives should be the same. If they were not—if rents were higher than the user cost, for example— then all market participants would want to buy, bidding up prices until the rental option cost the same. The important point here is the direct link between the net operating income of the rental option and prices, ownership costs, and expected capital gains of the ownership option. When purchasing CRE, market participants often link cap rates to expected future rental rates and vacancies. Expected increases in rent or lower vacancies tend to lower the cap rate. If rents are expected to increase, then the property has become more valuable and the owner will expect a higher capital gain, which will lead to a lower cap rate. A similar argument can be made for falling vacancies. Thus, expected price appreciation is ultimately a reflection of the outlook for fundamentals such as rents and vacancies. However, there could also be unidentified nonfundamental reasons for changes in expected price appreciation. For example, investor sentiment may improve and the discount rate applied to cash flows from a property may fall, thereby lowering the cap rate. Indeed, investor sentiment could become so exuberant that a bubble could form, in which expected appreciation soared and the cap rate dropped sharply. This link between cap rates, interest rates, and expected price appreciation is not merely theoretical. Using a slightly different representation of the cap rate, Ghysels, Plazzi, and Valkanov (2007) show that it predicts CRE returns. In our data we can see these linkages in Figure 2, which compares CRE cap rates with the interest paid on loans to finance CRE transactions. We focus here on the office market, but other CRE asset classes have behaved similarly. Ideally, the interest measure should be the rate on new CRE loans, but those are not readily obtainable. Instead, we use as a proxy for CRE purchase loans the yield on AAA-rated five-year commercial mortgage-backed securities (CMBS), which finance a large share of CRE transactions. Figure 2 Office building cap rates and CRE mortgage rates Sources: CB Richard Ellis (CBRE) and Commercial Real Estate Direct. 0 1 2 3 4 5 6 7 8 9 10 0 2 4 6 8 10 12 14 16 18 20 2004 2005 2006 2007 2008 2009 2010 2011 Percent Percent CMBS yield (left axis) Office cap rate (right axis) Summer 2010 Our valuation is driven by a 9.85% discount rate, a 2-3% rent growth rate and a 0.4% Cap Rate compression each year
1919 19 OUR RECOMMENDATIONS AND ADVICE 19
20 Strategic Summary We propose purchasing the debt, swapping it to equity, renovating the properties and exiting at the peak of the market in 2018 • Conduct due diligence:  Property Condition  Owner’s Equity  Any binding agreements between HRC Capital, senior debt holders and owner • Negotiate an interparty agreement between owner  Debt to Equity swap for the ownership interest in the property is viable Due Diligence Interparty agreementPrior to Acquisition • Purchase all Mezzanine offered at a 75-90% discount to its value • Conduct a Debt to Equity swap Purchase Mezzanine Debt • Owner will most likely default in payments  Senior debt will be compensated, but mezzanine debt may not be  We will not get our money back • Do not pursue investment any further Do not Purchase Mezzanine Debt SWAP • Refinance the senior debts at a lower interest rate • Renovate the office buildings to -  Suit changing contemporary economic conditions  Appreciate underlying value Occupy Ownership Interest of the Properties Owner DefaultsBuy or Pass Exit Strategy Contingencies SELL • Exit each office building in year for a total of $311M • Offering a levered IRR of 22.8% Exit the Office Buildings 2010-2018
21 Borrowe r Senior Debt Mezz Debt Senior Debt Mezz Debt Senior Debt Bryant Plaza Cutler Centre Rivers Tower Is the purchase of the mezzanine loans UCC (Uniform Commercial Code) approved? Negotiations and Due Diligence Questions Will inter-creditor agreements interfere with either the purchase of the loan or the Debt-Equity Swap? What upper-level debt agreements are the properties subject to? What senior mortgage covenants and restrictions is the property subject to? Is the borrower willing to swap the mezzanine loans for an equal proprietary interest in the building? Do the terms of the current capital structure allow for us to refinance immediately? Due Diligence & Negotiations We need to run a number of meetings and operate several due diligence checks before we proceed further… 2010 Due Diligence Checklist Property & Markets Borrower Position Legal Structure & Documents Other Creditors Servicing History
22 Acquiring the loans… The debt on the portfolio matures after the next interest payment, thus there is a clear need to refinance 2010 CUTLER CENTRE ACQUISITIO N • Targeting a 70% discount to the implied, risk free value of the loan. • Reflective of the fact that the loan will default as the property and capital structure are distressed • The fulcrum position of the loan with respect to the capital stack as a whole should allow us to pursue this discount PURCHASE PRICE: $6.2M RIVERS TOWER ACQUISITIO N • Target an identical 70% discount to the implied risk free value of the loan • Reflective of similar conditions to the Cutler Centre PURCHASE PRICE: $9.3M BRYANT PLAZA ACQUISITIO N • Bryant Plaza’s NOI is two times lower than their debt service requirements • Therefore it is the most distressed out of all three properties • Thus, we are targeting a 90% discount to the implied, risk free value of the loan. PURCHASE PRICE: $5.5< THE PORTFOLIO ACQUISITIO N • Overall, we are targeting a weighted discount of 75.26% • This is the minimum discount required to meet the 20% IRR requirement set out by Sun Rock Capital PURCHASE PRICE: $21M
23 Performing a debt to equity swap By nature, mezzanine debt is a more effective vehicle for pursuing loan-to-own strategies • Mezzanine are more flexible than senior debt • A debt-equity swap would avoid the borrower public embarrassment • Mezzanine debt cause a great deal of anxiety among borrowers for the following reasons • Mezzanine Debt commands a higher interest rate than senior debt, therefore it has a higher chance of default • If a borrower defaults on a mezzanine loan, the lender foreclose on the equity of the borrower rather than the property • Estimates of cash flows indicate the borrower will default on their next interest payment • This will allow the holder of the mezzanine to foreclose on the equity of the borrower • As a result, a default would be catastrophic for the borrower • A debt to equity swap would allow the borrower to avoid this issue PERSUASIVE FACTORS LEVERAGE TERMS OF SWAP TERMS • We will swap our mezzanine debt at 1:1 ratio, i.e. 1% debt is converted into 1% equity • We will take on the current obligations subject to the property and owed to senior and other mezzanine debt holders • We will take management of the property in all areas, such to indicate that we are the sole equity partner and owner of the properties Borrower Senior Debt Mezzanine Loan1 Mezzanine Loan 2 Senior Debt Mezzanine Loan1 Owner (Sunrock Capital) 2010
24 Refinancing the loans The debt on the portfolio matures after the next interest payment, thus there is a clear need to refinance 2010 CURRENT CAPITAL STRUCTURE CONDITIONS Capital Structure Of Properties: Cutler Center - Chicago Senior Loan: $35,000,000 First Mezzanine: $30,000,000 Second Mezzanine: $20,000,000 Rivers Tower - San Diego Senior Loan: $57,000,000 First Mezzanine: $25,000,000 Second Mezzanine: $30,000,000 Bryant Plaza - Los Angeles Senior Loan: $45,000,000 Mezzanine: $51,000,000 Cutler Centre – Refinanced Capital Structure & Conditions Senior Loan: Principal: $35,000,000 Loan Term (Years): 10 Rate: 4.50% Amortisation (Years): 30.00 Payment: $2,148,704 First Mezzanine: Principal: $30,000,000 Loan Term (Years): 7 Rate: 12.00% Amortisation (Years): IO 7 Payment: $3,600,000 Rivers Tower – Refinanced Capital Structure & Conditions Senior Loan: Principal: $57,000,000 Loan Term (Years): 10 Rate: 4.50% Amortisation (Years): 30.00 Payment: $3,499,318 First Mezzanine: Principal: $25,000,000 Loan Term (Years): 7 Rate: 12.00% Amortisation (Years): IO 7 Payment: $3,000,000 Bryant Plaza – Refinanced Capital Structure & Conditions Senior Loan: Principal: $45,000,000 Loan Term (Years): 10 Rate: 4.50% Amortisation (Years): 30.00 Payment: $2,762,619 Loan Structure TARGETED CAPITAL STRUCTURE STRUCTURE We are targeting a 4.5% fixed interest rate for senior debt. This is derived from similar loans at the time, and the competing impact of low interest rates and poor macroeconomics We target a 12% fully amortized structure for mezzanine loans. This will compensate investors for the risk they are taking.
25 Renovation as a defensive strategy… Renovation is necessary as a defensive move to lock in the Portfolio’s value in the heat of a strong bull market 2018 Renovation Rationale MARKET TRENDS STRUCTURE • As value and liquidity returns to the market, competition will follow • There will be strong growth in the number and value of new property projects • In order to be competitive in this environment, we need to keep our property up to date CONSUMER TRENDS STRUCTURE • At the peak of the market, there will be a set of consumer demands which will become standard for Class A properties • We must ensure that our properties are sufficiently equipped to meet the demands of both tenants in purchasers in 2018 BUILDING CLASSIFICATION STRUCTURE • If we do not ensure sufficient Capex, it is possible several properties may be downgraded to Class B
26 Cutler Centre – Creating a luxury entertainment space… The retail space in the Cutler Centre can be renovated and upgraded to leverage market cycles We propose upgrading and reconfiguring the 10,000sqft of retail space, with the following proportions of rental space in mind; • 40% of rental space dedicated towards formal luxury dining – This establishes a convenient platform for office tenants to use as a meeting and entertaining space • 40% of rental space dedicated towards casual dining – This leverages the catering needs of office space tenants • 20% of rental space dedicated towards a bar or other licensed facility – This helps meet the entertainment and social needs of tenants Luxury Entertaining UPGRADE An analysis of large scale retail space renovations indicates an average cost of between $340-1200 sq ft. We believe our renovations will cost roughly $5M Costings EVALUATION Measuring Return RESULTS 2013-2014 26 3% Post Value Add Growth Rate 1-1.5% Decrease in exit Cap Rate
27 Rivers Tower – Stronger communities… Updating shared spaces within the River Tower will drive down exit yields while increasing NOI We propose renovating the estimated 24,000 square feet of lobby and shared space in Rivers Tower. This will be critical to decreasing the vacancy rates, increasing rates and compressing exit yields • As we are aiming to sell at the peak of the market in 2018 , we believe it is critical to ensure the building is designed well – As such, we have allocated capital towards graphic design and architecture Lobby & Shared Space Upgrades UPGRADE An analysis of large scale office space renovations indicates an average cost of between $200-300 sq. ft. We believe our renovations will cost roughly $6M. Costings EVALUATION Measuring Return RESULTS 2013-2014 27 Post Value Add Growth Rate 1-1.5% Decrease in exit Cap Rate 2% 4.9-7M Value Add
28 Bryant Plaza – Changing the platform We can elevate Bryant Plaza’s value by changing the way space is utilized and leveraging it’s geographic position We are proposing two major changes to Bryant Plaza Rooftop Bar • The excellent views offered by Bryant Plaza create the opportunity for us to build a rooftop bar • This would drive up rent in 2018-19, increasing the sale price Underground Carpark • Bryant Plaza’s access to motorways creates an opportunity to generate excess cash returns • The Los Angeles population uses cars heavily Parking & Bars UPGRADE An analysis of large scale retail space renovations indicates an average cost of between $450 sqft. We believe our renovations will cost roughly $6M Costings EVALUATION Measuring Return RESULTS 2013-2014 Generates 1.8 extra revenue per annum Present Value of 6.8M
29 Exiting the position - Selling and Profiting… The debt on the portfolio matures after the next interest payment, thus there is a clear need to refinance 2018 5.5% Target Exit Cap Rate 311.4 USD Exit River Tower 125.7M USD Bryant Plaza 74.6M USD Cutler Center 111M USD 130M USD Levered Free Cash Flow in Year 8 WHY SELL IN 2018? Market Cycles Our analysis indicates that the market will peak between 2017 and 2020. In order to be conservative and avoid mistiming the market, we believe 2018 is strong target sale period Capitalization Rates We believe the current interest rate environment will persist in general terms for the next decade This, along with the general economic recovery, will compress capitalisation rates and thus increase our sale price
30 Increasing Likelihood IncreasingImpact Strategic Failure Macroeconomic Challenge Tenant Risk Matrix Overview: Commercial properties are sensitive to market conditions. Due to the post-recession environment, unemployment rates and US office market vacancy rates has increased steadily across the nation. We believe these factors may impact our ability to find quality tenants when rents rollover in 2012. Overview: Delinquency rates of commercial real estate loans are rising rapidly and the market currently holds record levels of outstanding commercial debt mortgage. Rent growth and net absorption has also experienced declines. We believe these factors proposes a risk of tenants’ default on lease repayments or loans. Overview: We believe we will be exposed to interest rate risks when we refinance our loans. Additionally, the presence of Mezzanine loans on two of the properties, which will lein on SunRock, need to managed carefully. Strategic Risks Overview: Exposure to senior debt risk. Construction and renovation risks due to impacted construction industry. Macroeconomic Risk Tenant Risk Financing Risk Strategic Risk Financing Failure Analysing Risk… The debt on the portfolio matures after the next interest payment, thus there is a clear need to refinance
31 Recapping our strategy We believe that performing a debt to equity conversion will allow us to deliver results in line with our portfolio’s needs 21M USD Purchase Equity Injection 17M USD 130M USD Free Cash Flow Exit 27M USD After conducting appropriate negotiations and due diligence, we should move to purchase the portfolio at a 75% discount to it’s face value. We should leverage our lein against the borrowers equity and our capacity to limit investor losses to convert out mezzanine loans to a proprietary interest in the properties We should renovate all three properties to maintain their class A classification. SWAPACQUIRE RENNOVATE We believe that we will be in the end of a strong bull real estate market in 2018. Thus, we should sell them SELL
3232 32 SUMMARY AND OVERVIEW 32
33 Valuing our returns We believe that performing a debt to equity conversion will allow us to deliver results in line with our portfolio’s needs Cutler Centre – West Loop, CH Bryant Plaza, Downtown, LA Rivers Tower – Downtown, SD The PortfolioProperty Returns Unlevered IRR: 63.20% Unlevered Equity Multiple: 13.70 x Levered IRR: 22.69% Levered Equity Multiple: 4.55 x Property Returns: Unlevered IRR: 48.12% Unlevered Equity Multiple: 9.28 x Levered IRR: 25.94% Levered Equity Multiple: 4.41 x Return Metrics Unlevered IRR: 55.96% Unlevered Equity Multiple: 11.47 x Levered IRR: 22.28% Levered Equity Multiple: 4.11 x 130M Levered Sale 27M Free Cash Flow Equity (excluding sale) 48M Levered Sale 6M Free Cash Flow Equity (excluding sale) 47M Levered Sale 2.68M Free Cash Flow Equity (excluding sale) 35.6M Levered Sale 17M Free Cash Flow Equity (excluding sale) Property Returns: Unlevered IRR: 56.61% Unlevered Equity Multiple: 11.53 x Levered IRR: 19.06% Levered Equity Multiple: 3.56 x
34 Recapping our presentation We believe that performing a debt to equity conversion will allow us to deliver results in line with our portfolio’s needs Acquisition and Due Diligence Debt- Equity Swap Holding & Renovation Sale & Exit Due Diligence Checklist Property & Markets Borrower Position Legal Structure & Documents Other Creditors Servicing History 21M Portfolio Purchase LEVERAGE We believe that our claim against the borrowers equity and said borrowers poor financial position will persuade the borrower to accept our DIL Persuasive Factors UPGRADES Renovations are necessary as a defensive move to ensure that the property remains Class A and can fully capture the economic recovery Defensive Renovations BEGINNINGS RETURNS Expected Returns Return Metrics Unlevered IRR: 55.96% Unlevered Equity Multiple: 11.47 x Levered IRR: 22.28% Levered Equity Multiple: 4.11 x
3535 35 APPENDIX 35
3636 36 APPENDIX DIVISION 1 – MARKET RESEARCH 36
37 W US Property Market Information CRE Index • Moodys/REAL commercial property price index • (CPPI) is based on actual repeat sales of a large sample of CRE properties • Transaction-based index (TBI) also uses sales prices, but employs a different index methodology and a smaller property sample. • Figure 1 shows the behaviour of the aggregated all-properties CPPI and TBI indexes from 2004 and 2011 properties, is about $11 trillion, according to the U.S. Commerce Department’s Bureau of Economic Analysis. That compares with an estimated $17 trillion in the total value of residential structures in the United States. Given the size of the market for commercial real estate (CRE), it is important to understand CRE price movements. The Massachusetts Institute of Technology Center for Real Estate publishes two widely used CRE price measures. The Moodys/REAL commercial property price index (CPPI) is based on actual repeat sales of a large sample of CRE properties. The transaction-based index (TBI) also uses sales prices, but employs a different index methodology and a smaller property sample. Figure 1 shows the behavior of the aggregated all-properties CPPI and TBI indexes from 2004 to 2011. From the second quarter of 2007 through the fourth quarter of 2009, both indexes dropped sharply, with the CPPI falling 41% and the TBI 39%. However, since the beginning of 2010, these indexes have been painting very different pictures. The CPPI indicates that, since the end of 2009, CRE prices have slid 7%. But the TBI indicates that CRE prices have actually risen 19% over that period. This unusual deviation in these two indexes raises the questions of whether CRE prices are currently recovering and how prices are likely to behave going forward. To explore what may happen to these prices, we consider the capitalization rate, or cap rate for short, as an alternative indicator of CRE valuations. Figure 1 Two measures of commercial real estate prices Sources: Moodys/MIT Center for Real Estate. Both indexes are based on “all properties.” 50 60 70 80 90 100 110 2004 2005 2006 2007 2008 2009 2010 2011 Index CPPI TBI
38 W Situational Overview Context Current date and location: North America Jan 1 2010 Unemployment topped 10% at end of 2009 Central business district offices fell about 53% from 2007 levels – this class is closely related to unemployment and hiring trends Market may bottom out in 2010 – office vacancies touching 19% - any recovery for offices dependent on jobs Some areas weathered the downturn better than others – location is important – focus on locations with educated workforces, strong population growth, prevalence of desirable industries such as IT Deal activity going forward to be focused on modern, well leased, stable cash flow, well positioned assets – outside these markets, recovery will lag for some time Overall delinquency rate (number of loans with delinquency payments/total number of loans held) has more than doubled since Aug 2008 Loans on properties in secondary markets are delinquent at about 2x the rate of those loans on primary market properties Investor profile SunRock Capital – opportunistic, global real estate investment management company Core (Core plus): least risky because often target stabilised, fully leased, secure investments in core markets; well kept and require no improvements by owner; usually warrants low leverage acquisitions Value add: seek to increase cash flow over time by making improvements to or reposition property; medium to high leverage used to acquire Opportunistic: require significant rehabilitation; usually fully vacant upon acquisition or need to be developed from the ground up; offer highest level of return if successful; bears most risk as property has no in-place cash flow; usually high leverage acquisitions HQ in NYC Past strategies: high yield superior risk adjusted returns; significant renovations of properties, foreclosures (loan to own scenarios – acquisition of secured debt position to influence control and ultimately acquire ownership of target); asset repositioning where relevant Most recent fund – SRC Capital VI Closed in Q1 2009 with $1.5b in equity from pension funds, endowments, sovereign wealth funds, HNW individuals Target gross returns of 20% IRR and 2x equity multiple on investment MOI – multiple on investment
39 W Situational Overview The opportunity Off market opportunity with another real estate private equity fund (HRC Capital) Opportunity: Buy a portfolio of 3 loans on class A office buildings in 3 different North American cities Classes reflect different risk and return – graded on location, physical characteristics, tenant levels, rental income etc. Class A = highest quality building in the area and market; generally newer properties built within the last 15 years with top amenities, high income earning tenants and low vacancy rates; well located in the market and typically professionally managed; typically demand highest rent with little or no deferred maintenance issues While HRC waits for our response, the loans will move between 60-90c on the dollar Each loan is at the fulcrum point in the capital stack of the corresponding property Capital fulcrum point – measures the annual % growth rate required from the underlying instrument for you to do equally well in terms of capital appreciation from its associated warrant (security that entitles the holder to buy the underlying stock of the issuing company at a fixed price called exercise price until the expiry date); the indifference point between buying a warrant rather than the stock in a company Warrants are derivative instruments, are dilutive (Receive new stock when exercised), do not pay dividends or come with voting rights; traditional warrants are issued with bonds ALL LOANS MUST BE PURCHASED IF THE DECISION IS BUY
40 W Situational Overview Portfolio & asset history Loans originated from part of a larger office portfolio acquisition at the peak of the market in 2007 Sponsor expected to find easy refinancing for the Class A, iconic assets when loans matured in mid-2012, given the properties’ (now aggressive) underwriting and assumed steady property market increases Properties are geographically dispersed Portfolio relatively uniform in quality The 3 buildings backing the loans are of a representative quality Loans organised in complex structure Debt was split and syndicated to multiple parties, including CMBS and mezzanine debt holders Commercial mortgage backed securities (CMBS) – type of MBS secured by mortgages on commercial properties. CMBSs are a group of commercial loans on properties such as apartment complexes, factories, office buildings etc. that are bucketed into various tranches (usually 3-4). Tranches are ranked from senior (highest quality) to lowest quality Mezzanine debt - occurs when a hybrid debt issue is subordinated to another debt issue from the same issuer. Mezzanine debt has embedded equity instruments attached, often known as warrants, which increase the value of the subordinated debt and allow greater flexibility when dealing with bondholders; enables firm to gain capital without offering any collateral, if business defaults on the loan, the lender can convert its loan into an ownership stake using options or warrants built into the deal; charges higher interest rate (usually 15-18%) due to lack of due diligence, higher risk and is subordinate to higher forms of debt; The value of the warrant is a floating number based on the future value of the company Mezzanine debt v senior debt: Mezzanine debt is a hybrid form of capital that is part loan and part investment. Senior debt is a loan from a bank. There are many differences between the two. Banks lend off of asset values so most senior loans are collateralized with assets. The bank loan is always secured and in the first position. Mezzanine debt is not collateralized by assets and is usually in the second position with assets. Mezzanine loans are made against the cash flow, not the assets of the business. Because of this feature, mezzanine debt providers use different criteria than banks in qualifying borrowers. They look closely at their EBITDA, their EBITDA margins, and the strength of their historical cash flow. When market declined and office portfolio didn’t perform to underwritten projections, delinquencies weighed on the 3 loans in the portfolio Sponsor worked with lenders on several strategies to consolidate loans and get them out of delinquency After successfully bringing the loans up to date, holder of mezzanine pieces (HRC Capital) decided to market the loans HRC offered a potential off market deal to SunRock before bringing the opportunity to more investors HRC (the borrower) is an established private equity fund – specialises on owning and operating office assets across US (bulk of portfolio in top quality assets in major urban markets such as NYC and WDC)
41 W US Property Market Information • The Federal Reserve left the target range for its federal funds rate unchanged at 1 percent to 1.25 percent during its July 2017 meeting and said it will start reducing its USD 4.5 trillion portfolio relatively soon. • The committee considered near-term risks to the economic outlook as roughly balanced, but said it will closely monitor inflation • Interest Rate in the United States averaged 5.78 percent from 1971 until 2017, reaching an all time high of 20 percent in March of 1980 and a record low of 0.25 percent in December of 2008.
42 W US Property Market Information Capitalisation Rates • If rents are expected to increase  property has become more valuable  owner will expect a higher capital gain lead to a lower cap rate • During GFC, CRE prices dropped about 40% and the market for financing CRE transactions was severely disrupted, resulting in very high CMBS yields. • Since summer 2010, yields on highly rates CMBS have increased about 0.30%. However, cap rates have come down 0.50%. – Decline in cap rates despite the slight increase in interest rates suggest that investor expectations for CRE price appreciation have strengthened has become more valuable and the owner will expect a higher capital gain, which will lead to a lower cap rate. A similar argument can be made for falling vacancies. Thus, expected price appreciation is ultimately a reflection of the outlook for fundamentals such as rents and vacancies. However, there could also be unidentified nonfundamental reasons for changes in expected price appreciation. For example, investor sentiment may improve and the discount rate applied to cash flows from a property may fall, thereby lowering the cap rate. Indeed, investor sentiment could become so exuberant that a bubble could form, in which expected appreciation soared and the cap rate dropped sharply. This link between cap rates, interest rates, and expected price appreciation is not merely theoretical. Using a slightly different representation of the cap rate, Ghysels, Plazzi, and Valkanov (2007) show that it predicts CRE returns. In our data we can see these linkages in Figure 2, which compares CRE cap rates with the interest paid on loans to finance CRE transactions. We focus here on the office market, but other CRE asset classes have behaved similarly. Ideally, the interest measure should be the rate on new CRE loans, but those are not readily obtainable. Instead, we use as a proxy for CRE purchase loans the yield on AAA-rated five-year commercial mortgage-backed securities (CMBS), which finance a large share of CRE transactions. Figure 2 Office building cap rates and CRE mortgage rates Sources: CB Richard Ellis (CBRE) and Commercial Real Estate Direct. 0 1 2 3 4 5 6 7 8 9 10 0 2 4 6 8 10 12 14 16 18 20 2004 2005 2006 2007 2008 2009 2010 2011 Percent Percent CMBS yield (left axis) Office cap rate (right axis) Summer 2010
43 W US Property Market Information Terminology: Net Absorption: Absorption is the amount of space or units leased within a market or submarket over a given period of time (usually one year). Absorption considers both construction of new space and demolition or removal from the market of existing space. It represents the demand over a specified period, contrasted with supply. When supply is less than demand, vacancy decreases and absorption is positive. When supply is greater than demand, vacancy increases and absorption is negative.
44 W Chicago Property Market Information Overall, the CBD remains a landlord’s market as rent continues to increase across all building classes and fewer concessions are granted. Limited availability of quality high-rise space coupled with continued corporate migration into the CBD has solidified an advantageous environment for landlords; however, tenants in a position to open negotiations with landlords in 2017 will be looking at a more tenant favourable market as approximately 2.3 million square feet are delivered in early 2017. As this space is delivered to the market, landlords will seek to avoid losing tenants to the new developments, which will likely increase concessions granted to tenants. Investors see value in Chicago’s assets as they offer a significant discount in pricing relative to comparative properties on the coasts and believe Chicago’s diverse economy and talented workforce make for strong investments.
45 W Chicago Property Market Information • From 2009 – 2015, the vacancy rates have continually dropped – Total decline of 3.8% • Period 2009 had a net absorption of - 1,614,937 – Oversupply of office properties • Can be explained by the effect of the GFC that caused a loss of jobs, a decline in real income, a slowdown in industrial production and manufacturing and a slump in consumer spending • From 2010 – 2011, economy began to recover as vacancy rates declined and net absorption levels became positive again.
46 W Chicago Property Market Information • From 2009 – 2015, the vacancy rates have continually dropped – Total decline of 3.8% • Period 2009 had a net absorption of - 1,614,937 – Oversupply of office properties • Can be explained by the effect of the GFC that caused a loss of jobs, a decline in real income, a slowdown in industrial production and manufacturing and a slump in consumer spending • From 2010 – 2011, economy began to recover as vacancy rates declined and net absorption levels became positive again. • The CBD’s overall vacancy decreased by 70 basis points over the past year, falling from 12.3 percent to 11.5 percent. Vacancy decreased by at least 50 basis points across all assets classes, with Class A leading the way with an 80 basis point decrease during the
47 W Chicago Property Market Information Asking Rental Rates The average direct asking rental rate in the CBD currently resides at $36.92 per square foot, an increase from $36.16 per square foot in the third quarter. The average overall asking rental rate increased by 5.43 percent from one year prior. Investment Sales and Deal Activity • 2009 represents a period of low sales activity, however from 2009-2013 there has been a significant growth in the number of sales activity (3 to 31 sales) • Class B offices seems to be frequently traded more than Class A and C • The market remains incredibly hot for sellers, and there is little reason to suspect investment sales activity will slow.
48 Chicago Property Market Information
49 W Los Angeles Property Market Information • Net Absorption: The absorption rate is the rate at which available properties are sold in a specific real estate market during a given time period. It is calculated by dividing the total number of available homes by the average number of sales per month. cushmanwakefield.com I 5 MARKETBEAT About Cushman & Wakefield Cushman & Wakefield is a leading global real estate services firm that helps clients transform the way people work, shop, and live. Our 43,000 employees in more than 60 countries help investors and occupiers optimize the value of their real estate by combining our global perspective and deep local knowledge with an impressive platform of real estate solutions. Cushman & Wakefield is among the largest commercial real estate services firms with revenue of $5 billion across core services of agency leasing, asset services, capital markets, facility services (C&W Services), global occupier services, investment & asset management (DTZ Investors), project & development services, tenant representation, and valuation & advisory. To learn more, visit www.cushmanwakefield.com or follow @CushWake on Twitter. Copyright © 2017 Cushman & Wakefield. All rights reserved. The information contained within this report is gathered from multiple sources considered to be reliable. The information may contain errors or omissions and is presented without any warranty or representations as to its accuracy. Greater Los Angeles Office Q1 2017 OFFICE SUBMARKETS Cushman & Wakefield 601 S. Figueroa Street 47th Floor Los Angeles, CA 90017 For more information, contact: Eric Kenas, Market Director, Research Tel: +1 213 955 6446 eric.kenas@cushwake.com Vincent Chang, Senior Analyst Tel: +1 213 955 5125 vincent.chang@cushwake.com Greater Los Angeles Office Q1 2017 Economic Indicators Market Indicators (Overall, All Classes) Overall Net Absorption / Overall Asking Rent 4Q TRAILING AVERAGE Q1 16 Q1 17 12-Month Forecast Los Angeles Employment 4.36M 4.44M Los Angeles Unemployment 5.6% 4.9% U.S. Unemployment 4.9% 4.8% Q1 16 Q1 17 12-Month Forecast Vacancy 14.4% 14.4% YTD Net Absorption (SF) 1.4M 232K Under Construction (SF) 1.8M 2.4M Average Asking Rent* $2.84 $3.13 *Rental rates reflect gross asking $PSF/MO Economy U.S. job growth trend remains firmly in place and nonfarm payroll employment has now increased for 78 consecutive months. Employment growth in the first quarter of 2017 was solid—averaging 178,000 jobs per month. The unemployment rate in Los Angeles County reached its lowest level in 10 years, declining to 4.8% in February. In the last year, nonfarm employment grew by 70,800, or +1.6%. Education and health services listed the largest employment gains, adding 31,300 jobs. The only sector with a reduction in jobs was manufacturing, influenced primarily by the increasing weakness in the apparel industry. Unemployment is expected to decline slowly over the next two years as the county reaches full employment in 2018. Market Overview First quarter leasing activity of 2.7 million square feet (MSF) fell short of the 3.5 MSF quarterly average in 2016. Activity was largely concentrated in LA West with over 1.0 MSF of new leasing and also making up more than half of the top key transactions. Net absorption was positive for the 14th consecutive quarter, but due to major construction completions in each of the past four quarters, overall vacancy remained relatively flat year-over-year (YOY) at 14.4%. New high-end product catering to the rapidly evolving tenant demands has helped push overall average asking rental rates to $3.13 per square foot per month (PSF/MO), for an increase of 10.2% from a year ago. This was the first time since 2008 that there has been such a vigorous YOY increase in average asking rental rates. Most of this rent growth was attributed to submarkets outside of the CBD. LA Metro (non-CBD) overall average asking rents have increased by over +9% YOY, whereas in the CBD they’ve increased by +4.6%. In a sign of increased demand within the CBD, prominent tenants are moving into the market and some CBD landlords are now asking as high as almost $5.00 PSF/MO for premium space. Investment sales volume by SF outpaced first quarter 2016 by +14%, reaching 4.1 MSF. With 1.4 MSF or 34% of the transactions occurring in TriCities, specifically the highest volume in Glendale. There are 3.4 MSF of office developments in the Greater LA construction pipeline, with LOS ANGELES COUNTY $2.25 $2.50 $2.75 $3.00 $3.25 -500 0 500 1,000 1,500 2012 2013 2014 2015 2016 2017 Net Absorption, KSF Asking Rent, $ PSF cushmanwakefield.com I 1 Overall Vacancy increase of 10.2% from a year ago. This was the first time since 2008 that there has been such a vigorous YOY increase in average asking rental rates. Most of this rent growth was attributed to submarkets outside of the CBD. LA Metro (non-CBD) overall average asking rents have increased by over +9% YOY, whereas in the CBD they’ve increased by +4.6%. In a sign of increased demand within the CBD, prominent tenants are moving into the market and some CBD landlords are now asking as high as almost $5.00 PSF/MO for premium space. Investment sales volume by SF outpaced first quarter 2016 by +14%, reaching 4.1 MSF. With 1.4 MSF or 34% of the transactions occurring in TriCities, specifically the highest volume in Glendale. There are 3.4 MSF of office developments in the Greater LA construction pipeline, with nearly 2.0 MSF delivering by the end of 2017. Outlook The office sector is evolving as the definition of creative space broadens and new tech innovations shape up the modern day workplace. These new requirements are impacting nearly every submarket in Greater LA. Office demand is driven by the labor market, and as we approach full employment leasing should remain robust and continued rent growth is expected. In 2017, new office supply catering to these demands may cause vacancy to decline at a more tepid pace. Los Angeles is at the top of list as an investment target market nationally and sales volume is anticipated to exceed 2016 levels and with higher per square foot prices. $2.25 $2.50 $2.75 $3.00 -500 0 500 1,000 2012 2013 2014 2015 2016 2017 Net Absorption, KSF Asking Rent, $ PSF 10% 12% 14% 16% 18% 20% 2012 2013 2014 2015 2016 2017 5-Year Historical Average = 16.6% MARKETBEAT Greater Los Angeles Office Q1 2017 MARKET TOTAL BUILDINGS INVENTORY (SF) DIRECT VACANCY RATE OVERALL VACANCY RATE YTD LEASING ACTIVITY (SF) YTD OVERALL NET ABSORPTION (SF) UNDER CONSTRUCTION (SF) OVERALL AVERAGE ASKING RENT (ALL CLASSES)* DIRECT AVERAGE ASKING RENT (CLASS A)* Los Angeles CBD 54 27,218,777 19.1% 19.9% 253,089 17,749 356,141 $3.42 $3.49 Los Angeles Central (Non-CBD) 140 20,315,970 14.3% 14.3% 128,374 378,046 334,201 $2.63 $2.75 Los Angeles West 416 52,797,801 11.3% 12.3% 1,011,384 (465,863) 1,171,175 $4.51 $4.64 Los Angeles North 407 31,332,528 10.6% 11.0% 506,752 36,897 355,000 $2.40 $2.50 Los Angeles South 249 30,182,254 15.5% 16.1% 447,561 349,126 159,087 $2.35 $2.68 TriCities 195 24,265,956 12.9% 13.8% 196,036 107,111 0 $2.96 $2.96 San Gabriel Valley 170 12,596,238 16.2% 16.5% 161,009 (190,860) 0 $2.15 $2.33 GREATER LOS ANGELES TOTALS 1,631 198,709,524 13.7% 14.4% 2,704,205 232,206 2,375,604 $3.13 $3.47 *Rental rates reflect gross asking $PSF/MO ngeles tely as overall vacancy rates is point (BP) decrease YOY. ince this time last year, R). Class A direct asking rents g by $0.06 PSF/MO to $3.49 YR). First quarter leasing activity terly average. Increased rket close four of the top five nference and event hosting at Wells Fargo North Tower. ifornia took space in Bunker Hill ly. Overall net absorption was saw some intra-market ions or new tenant migration. mmands the highest asking ongest rent growth. Over the ased by +12.8% for all classes wth was in Playa Vista and at $5.25 PSF/MO and $4.91 een a growth in inventory as e first quarter; with more to d is strong as leasing volume over +7% higher than the completions in 2017 will bolster rly for Class A product. ains to be seen if the market will supply delivering in 2017. ties as direct vacancy rates Direct Rental vs. Vacancy Rate CENTRAL BUSINESS DISTRICT Direct Rental vs. Vacancy Rate TRICITIES $2.92 $2.94 $3.19 $3.22 $3.37 $3.44 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% $0.00 $1.00 $2.00 $3.00 $4.00 2012 2013 2014 2015 2016 Q1 2017 PSF/YR DIRECT GROSS RENTAL RATE DIRECT VACANCY RATE Direct Rental vs. Vacancy Rate LOS ANGELES WEST $3.34 $3.43 $3.64 $4.01 $4.33 $4.55 0.0% 5.0% 10.0% 15.0% 20.0% $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 2012 2013 2014 2015 2016 Q1 2017 PSF/MO DIRECT GROSS RENTAL RATE DIRECT VACANCY RATE
50 W Los Angeles Property Market Information • Education and Unemployment • The highest unemployment rates, in both the City of Los Angeles and Los Angeles County, exist for individuals with an educational attainment of high school or less (Exhibit E-6). • Residents with a Bachelor’s degree or higher had an unemployment rate of 5.9 percent in the County (7.0 percent in the City) in 2013, roughly half the rate experienced by those at the opposite end of the spectrum—less than a high school education and high school diploma or equivalent reported unemployment rates of 10.1 percent usually face challenges such as higher unemployment and poverty and will there higher levels of public services and resources. The city and county both have a large proportio resident population with low levels of ed attainment (Exhibit E-5). Almost 25 percen population has less than a high school educa high school graduates (or equivalent) accoun additional 20 percent. As an increased numbe require higher skill levels, a shortage of individ higher levels of education can result in fewer p for their employment, and consequently higher unemployment. Education and Unemployment The highest unemployment rates, in both the Ci Angeles and Los Angeles County, exist for in with an educational attainment of high schoo (Exhibit E-6). Residents with a Bachelor’s degree or higher unemployment rate of 5.9 percent in the Cou percent in the City) in 2013, roughly half experienced by those at the opposite end spectrum—less than a high school education school diploma or equivalent reported unemp rates of 10.1 percent (9.6 percent) and 10.8 (11.6 percent) respectively. Less than HS 23.1% Less than HS 25.4% HS or equivalent 20.4% HS or equivalent 19.4% Some College 19.4% Some College 17.9% Associates 7.0% Associates 6.0% Bachelor's 19.7% Bachelor's 20.9% Masters 6.8% Masters 6.6% PhD or Prof'l 3.6% PhD or Prof'l 3.9% LA County City of LA Population 25 years and over City of LA: 2.6 million Source: 2013 ACS 1-year estimates 8.6% 9.2% 10.1% 9.6% 10.8% 11.6% 9.2% 10.0% 5.9% 7.0% LA County City of LA Exhibit E-6 Civilian Unemployment Rate by Educational Attainment 2013 Population 25 to 64 years Less than High School High School or equiv Some college or Associate's Bachelor's or higher Source: 2013 ACS 1-year estimates Executive Summary Exhibit E-12 Industry Employment Growth 2014-2019 in Los Angeles Annual Average % Δ Employment Em Em Co ec Lo an Fr re tro th re Th an th pe wh 6.2 Re oc int lab Mo po Ho Re ma Ind to re 8.7% 7.5% 8.3% 6.2% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Exhibit E-10 Unemployment Rate City of LA California LA County United States Sources: CA EDD, BLS 3.4 3.6 3.8 4.0 4.2 4.4 4.6 2007 2010 20132014 '15f '16f '17f '18f '19f Exhibit E-11 Nonfarm Employment in Los Angeles County (millions of jobs) Sources: CA EDD; Moody's Analytics; LAEDC Lost jobs are recovered by 2015
51 W Los Angeles Property Market Information • Employment, Industries and Jobs • Los Angeles County was hard hit during the recession, and has experienced a slow and anaemic recovery. From an employment base of 4.2 million at the pre- recession peak in December 2007 to a post-recession trough of 3.9 million, the county saw a loss of more than 330,000 jobs, and an unemployment • an unemployment rate consistently 10 percent above the county average, standing currently at 8.7 percent—both are above the state rate of 7.5 percent, which is also above the national rate, which stood at 6.2 percent in 2014. • Most industry sectors will follow this general contour of post- recession recovery followed by moderation. However, there are differences among industries. Recovery strength in many cases is determined by the magnitude of the industry’s decline during the recession. Industries where employment fell steeply are expected to experience stronger than average growth as they recover from these deep losses. • Recovery of all jobs lost during the recession did not occur until 2015 (Exhibit E-11). Still, this does not take into account the job growth needed to accommodate labour force growth. • The expected employment growth in individual sectors at the county level is shown in Exhibit E-12. While these growth rates are expected to apply at the city level as well, the projected job creation will differ given the different mix of industries in the two regions. • Between 2014 and 2019, the economy is expected to add 322,000 new jobs in nonfarm industries across Los Angeles County, and 126,000 new jobs in the Exhibit E-12 Industry Employment Growth 2014-2019 in Los Angeles Annual Average % Growth Δ Employment (000s) Total Nonfarm Payroll Employment 1.5% 322.0 Good Producing Industries: 0.5% 12.4 Natural Resources and Mining (1.4%) -0.3 Construction 1.8% 11.9 Manufacturing – Durable Goods 0.1% 2.1 Manufacturing – Nondurable Goods (0.0%) -1.2 Service Providing Industries 1.8% 287.6 Wholesale Trade 0.8% 8.6 Retail Trade 0.7% 14.7 Transportation, Warehousing, Utilities 0.7% 5.5 Employment, Industries and Jobs Employment opportunities for residents of Los Angeles County will depend on the health of the regional economy. Los Angeles County was hard hit during the recession, and has experienced a slow and anemic recovery. From an employment base of 4.2 million at the pre- recession peak in December 2007 to a post-recession trough of 3.9 million, the county saw a loss of more than 330,000 jobs, and an unemployment rate reaching a high of 12.6 percent (Exhibit E-10). The City of Los Angeles fared somewhat worse, with an unemployment rate consistently 10 percent above the county average, standing currently at 8.7 percent—both are above the state rate of 7.5 percent, which is also above the national rate, which stood at 6.2 percent in 2014. Recovery of all jobs lost during the recession did not occur until 2015 (Exhibit E-11). Still, this does not take into account the job growth needed to accommodate labor force growth. Most industry sectors will follow this general contour of post-recession recovery followed by moderation. However, there are differences among industries. Recovery strength in many cases is determined by the magnitude of the industry’s decline during the recession. Industries where employment fell steeply are expected to experience stronger than average growth as they recover from these deep losses. The expected employment growth in individual sectors at the county level is shown in Exhibit E-12. While these growth rates are expected to apply at the city level as well, the projected job creation will differ given the different mix of industries in the two regions. Between 2014 and 2019, the economy is expected to add 322,000 new jobs in nonfarm industries across Los Angeles County, and 126,000 new jobs in the City of Los Angeles. 8.7% 7.5% 8.3% 6.2% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Exhibit E-10 Unemployment Rate City of LA California LA County United States Sources: CA EDD, BLS 3.4 3.6 3.8 4.0 4.2 4.4 4.6 2007 2010 20132014 '15f '16f '17f '18f '19f Exhibit E-11 Nonfarm Employment in Los Angeles County (millions of jobs) Sources: CA EDD; Moody's Analytics; LAEDC Lost jobs are recovered by 2015 iv Exhibit E-12 Industry Employment Growth 2014-2019 in Los Angeles Annual Average % Growth Δ Employment (000s) Total Nonfarm Payroll Employment 1.5% 322.0 Good Producing Industries: 0.5% 12.4 Natural Resources and Mining (1.4%) -0.3 Construction 1.8% 11.9 Manufacturing – Durable Goods 0.1% 2.1 Manufacturing – Nondurable Goods (0.0%) -1.2 Service Providing Industries 1.8% 287.6 Wholesale Trade 0.8% 8.6 Retail Trade 0.7% 14.7 Transportation, Warehousing, Utilities 0.7% 5.5 Information 1.4% 14.7 Financial Activities 1.2% 13.1 Professional and Business Services 2.1% 67.8 Educational and Health Services 2.7% 105.6 Leisure and Hospitality 2.3% 54.7 Other Services 0.5% 4.0 Government 0.8% 20.6 Sources: California Employment Development Department; LAEDC The C an une the c percen which 6.2 pe Recove occur into a labor f Most i post-re Howev Recove magni Indust to exp recove The ex at the growth well, t differe Betwe 322,00 Angele Angele 3.4 3.6 3.8 4.0 4.2 4.4 4.6 2007 2010 20132014 '15f '16f '17f '18f '19f Exhibit E-11 Nonfarm Employment in Los Angeles County (millions of jobs) Sources: CA EDD; Moody's Analytics; LAEDC Lost jobs are recovered by 2015
52 Los Angeles Property Market Information Executive Summary Los Angeles: People, Industry and Jobs 2014-2019 Exhibit E-13 Occupational Growth in Los Angeles County 2014-2019 (Δ Employment) SOC Occupational Group New Jobs Replace- ment Total * 11-0000 Management occupations 14,130 25,810 39,940 13-0000 Business and financial 13,440 23,520 36,960 15-0000 Computer and mathematical 8,100 7,740 15,840 17-0000 Architecture and engineering 2,790 7,790 10,580 19-0000 Life, physical, social science 2,130 5,210 7,330 21-0000 Community and social services 9,200 8,060 17,260 23-0000 Legal occupations 1,960 3,720 5,680 25-0000 Education, training and library 13,030 22,510 35,540 27-0000 Arts, entertainment, sports 6,110 18,850 24,960 29-0000 Healthcare practitioners 26,720 20,230 46,950 31-0000 Healthcare support 16,500 9,180 25,680 33-0000 Protective services 10,500 13,400 23,900 35-0000 Food preparation and serving 45,210 63,460 108,670 37-0000 Building/grounds maintenance 17,300 13,400 30,700 39-0000 Personal care and service 20,850 18,610 39,460 41-0000 Sales and related 20,480 62,990 83,470 43-0000 Office and administrative 50,090 74,190 124,280 45-0000 Farming, fishing and forestry 130 730 860 47-0000 Construction and extraction 9,920 8,830 18,750 49-0000 Installation, maint / repair 6,530 13,160 19,690 51-0000 Production 7,940 24,190 32,030 53-0000 Transportation/material moving 15,960 34,530 50,490 Total* 322,000 480,000 802,000 * May not sum due to rounding Source: Estimates by LAEDC Less than HS 33.9% HS, no exp 29.0% HS, some exp 5.9% Postsecondary non-degree award 5.3% Associate's 4.4% Bachelor's, no exp 11.3% Bachelor's, some exp 5.2% Master's 1.6% Doctoral or professional degree 2.2% Exhibit E-14 Entry Level Education and Experience Requirements Source: Estimates by LAEDC
53 W San Diego Property Market Information • The effect of the GFC caused construction of office buildings to lessen, due to the fact that less offices were being demanded, and so the supply overweighed the demand. • From 2006 – 2008, Net absorption trended downwards whilst vacancy rates increased. In addition, the number of offices constructed began to lessen from the onset of the GFC. • From 2009 onwards, vacancy rates have decreased, whilst net absorption gradually increased.
54 W San Diego Property Market Information • Construction activity has exceeded 1.5 million SF and by year-end, will be at its highest level since 2008. With only 551,349 SF currently under construction, there is no concern for over- building as was the case prior to the recession that began in 2007. Additionally, demand since 2014 remains as strong – if not stronger – than most of the years prior to the recession.
55 San Diego Property Market Information • California and San Diego economy showing signs of improvement • Housing market strengthening • Unemployment declining • But employment conditions still difficult for many • Considerations for LMI workers • Fewer mid‐wage jobs, more low‐wage jobs • Most low‐wage jobs don’t pay living wages • Increasing importance of educational attainment U.S.GDPgrowth0.4%forQ42012 ‐10 ‐8 ‐6 ‐4 ‐2 0 2 4 6 20052006200720082009201020112012 Percent Change Percent Change in Real GDP, 2005‐2012 Source: Bureau of Economic Analysis 4thQ 2008: TARP 1stQ 2009: ARRA Californiamortgagedelinquenciescontinuetofall 0 200,000 400,000 600,000 800,000 20052006200720082009201020112012 Number of Mortgages Loans in ForeclosureAll Mortgages Past Due Source: Mortgage Bankers Association, National Delinquency Survey CaliforniaandNevadahavethehighest unemploymentamong12thDistrictstates 11.8 10.8 8.9 8.4 8.4 7.1 7.5 6.2 5.9 9.6 9.6 8.4 7.9 7.5 6.5 6.2 5.2 5.2  ‐  2  4  6  8  10  12  14 NVCAORAZWAAKIDHIUT Unemployment Rate (seasonally adjusted) Unemployment Rates in the 12th District Feb. 2012Feb. 2013 U.S. (Feb. 2013) ‐7.7% Source: Bureau of Labor Statistics
56 San Diego Property Market Information Californialaborforcecontinuestogrow, employmentrecovering 14 15 16 17 18 19 20032004200520062007200820092010201120122013 Individual Workers (in millions) Labor Force and Employment in California, 2003‐2013 Labor Force Employment Source: Bureau of Labor Statistics Californiahasaddedjobsforthelastseveral quarters,SanDiegojobgrowthonpace ‐8% ‐6% ‐4% ‐2% 0% 2% 4% 200120022003200420052006200720082009201020112012 Employment (Year‐over‐Year Growth) CALASD Source: Bureau of Labor Statistics (quarterly data through end of 2012) SanDiegoemploymentcontinuestogrow 1,140 1,160 1,180 1,200 1,220 1,240 1,260 1,280 1,300 1,320 1,340 2003200420052006200720082009201020112012201 Total Nonfarm Employment (in thousands) Total Nonfarm Employment (in thousands) 2003‐2013 San Diego‐Carlsbad‐San Marcos  Recession Source: Bureau of Labor Statistics, not seasonally adjusted Source: National Employment Law Project ‐21% ‐60% ‐19% 58% 22% 20% ‐80%‐60%‐40%‐20%0%20%40%60%80% Lower Wage Mid Wage Higher Wage Jobs Lost in the RecessionJobs Gained in the Recovery Growthinlowerwagework Source: National Employment Law Project ‐21% ‐60% ‐19% 58% 22% 20% ‐80%‐60%‐40%‐20%0%20%40%60%80% Lower Wage Mid Wage Higher Wage Jobs Lost in the RecessionJobs Gained in the Recovery Growthinlowerwagework
5757 57 APPENDIX DIVISION 2 – STRATEGIC RESEARCH 57
5858 58 SUBDIVISION 1 – LEGAL & GEOGRAPHIC RESEARCH 58
59 W Due Diligence Checklist Property and Local Market Conditions 1. Property type and physical condition / quality 2. Property location and competitive position 3. Property cash flows over the loan period 4. Property values (today, at maturity, at stabilization, in liquidation and recovery) 4. Rent rolls 5. Capital needs 6. Tenant defaults and payment delays, retention and renewals 8. Significance of personal property 9. Local market and sub market conditions Borrower Capabilities and Motivation 1. Borrower/sponsor financial and managerial strength 2. Extent of distress on borrower’s other properties / businesses 3. Borrower’s exposure on guarantees (contingent, full repayment, completion, or loss recovery) 4. Borrower’s tax position 5. Borrower’s reliance on management fee revenue (property, asset management, etc.) 6. The ownership entity’s control, capital structure, and approval processes These factors are essential as they influence the borrower’s behaviour and negotiating strategy. It can vary from obtaining a release from personal guarantees (DIL), maintaining control of the property to protect or to participate in its potential upside recovery, preserving management fee revenues, contributing and getting credit for ‘new’ money, pursuing bankruptcy or lender liability actions, and / or managing tax consequences and timing. Legal Structures and Documents Loan documents and key terms such as interest rates, maturities, escrows, and lock boxes Mortgages, assignments and other security Guarantees Additional collateral Other credit support Development and management agreements Lender recognition of agreements including leases Assignments of rents and receivables Lender lock box arrangements for collection of rents Default events, rights, and remedies Lender rights, obligations, and exposure under documents Other Creditors Construction trade claims Mechanics liens Other mezzanine debts Inter-creditor agreements Other secured or unsecured debt Servicing History Review of the loan servicing history and files can be used to develop pricing assumptions. Servicing files can be used to help indicate whether the property or borrower has supported the debt. Servicing and payment history and sources Servicing and correspondence Existence and status of any defaults Correspondence to/from borrower Financial analysis of borrower and guarantors Availability of assets to satisfy guarantees
60 W Legal Background Mezzanine financing tends to be highly negotiated and customised for the particular situation. Type of Instrument MF typically consist of unsecured or second lien debt, or less frequently, preferred stock. In practice, most mezzanine financing, particularly for larger financings, takes the form of subordinated, unsecured debt. Initial structuring discussions often focus on whether the debt should be in the form of loans or debt securities, with the investors' view of the likely resale market (bank or bond) driving the result. MF in the form of debt often includes equity participation, in the form of warrants, options and/or conversion features or co-investment rights associated with the primary mezzanine investment. Covenants Key negative covenants in mezzanine debt may include limitations on: Incurrence of debt. Restricted payments (including dividends, repurchases of equity and junior debt, and certain types of investments). Liens. Change of control transactions. Asset sales. Affiliate transactions. Affirmative covenants may include those relating to: Financial reporting. Maintenance of insurance. ERISA compliance. Equity Participation Mazanine investors regularly seek to enhance their returns by negotiating for equity participation alongside debt investments. This can take various forms: Warrants or options to purchase a specified percentage of equity (1-5% usually) Right to co-invest in the issuer alongside the controlling stockholder or a PE sponsor. Purchased equity would usually be bound by the terms of any stockholders’ agreement or other arrangement among other stockholders. Conversion feature that allows mezzanine investors to convert all or a portion of their principal investment into common equity of the issuer.
61 W Legal Background Inter-creditor Relationships Senior debt holders have ability to suspend payments to mezzanine debtholders for up to 179 days in cases of default. While precedents vary, in cases where mezzanine investors will receive only limited equity interests in the issuer, ordinarily they have limited leverage to negotiate for more than standard tag-along rights and registration rights, as well as customary anti-dilution protections. In cases where mezzanine investors are also taking larger equity stakes, however, they may also negotiate for veto rights for specified corporate actions including equity offerings, mergers, affiliate transactions or changes in senior management. Mezzanine borrower typically only owns limited liability interests in a limited liability company Addition of a mezzanine loan to the borrowing structure can bring the total loan-to-value ratio of a transaction to 90-95%. Limitations on Rights and Remedies under Intercreditor Agreements Mezz loans are typically contractually subordinated to the related senior mortgage loans pursuant to the terms of an Intercreditor agreement entered into between the senior mortgage lender and mezzanine lender. These agreements severely limit and restrict the ability of mezz lenders to enforce their rights and remedies under the mezz loan documents. Commercial Mortgage Securities Association (CMSA) have developed model forms that have become the industry norm on the content and coverage of these Intercreditor agreements. The agreements limit the mezz lender’s ability to control Equity Interest and to establish indirect control of the underlying real estate and to make certain decisions and take certain actions without the senior mortgage lender’s consent. The Intercreditor agreement typically requires borrower to obtain a ‘no downgrade letter’, which provides confirmation from rating agencies that mezz lender’s enforcement actions will not cause a downgrade of the rating of the related CMBS issurance which is secured. The Intercreditor agreements also place strict limitations on the identity of the mezzanine lender since it may succeed to the indirect ownership of the underlying mortgage borrower and therefore end up being the owner and operator of the land serving as collateral for the mortgage. The only ability of the mezzanine lender to escape the confines of the senior morgtage is to buy out the senior lender. If there is a default under the senior mortgage loan, most Intercreditor agreements grant the mezz lender to purchase the senior mortgage loan. Even if the mezzanine lender is able to obtain control of the mortgage borrower, its rights remain very limited not only because of the restrictions in the Intercreditor agreement, but also because the mezzanine lender (in its new capacity as mortgage borrower) is still subject to the senior mortgage covenants and restrictions.
62 W Legal Background Inter-creditor Relationships The senior mortgage typically contains many limitations on the ability to sell the property, make major improvements to the property, change control of the property, or undertake other major decisions without the senior mortgage lender’s consent. The only option available is to refinance the property or to buy out the senior lender at par. Mezz lenders are further restricted since they rarely succeed to the benefits from certain third-party agreements such as ground leases, subordination and non-disturbance agreements, etc. The mezz lender is under time pressure and must realise upon its collateral and exercise its remedies prior to the senior mortgage lender completing a foreclosure on the underlying mortgage. Once the senior mortgage lender completes its foreclosure, the underlying mortgage borrower will no longer own the income producing property and the mezz borrower will own equity in an entity with no assets. In the case the underlying mortgage borrower sells the property, the mezz lender’s only action against the mezz borrower is for a breach of the contractual promise not to sell. Compared to the senior mortgage lender’s right to foreclose its senior mortgage, the mezz lender’s right to foreclose on the Equity Interests of the mezzanine borrower is riskier and of limited value. Upon default, the mezz lender’s remedies derive solely from its lien on personal property (i.e. the equity in the mezz borrower). This means the mezz lender has no rights to foreclose any other liens on the underlying real property, its rights are limited solely to foreclosing junior liens on the equity in the mezzanine borrower and not the real property. What this means is that even after a successful foreclosure of a mezzanine loan, the underlying mortgage property remains subject to the lien of the senior mortgage as well as any other liabilities, liens, leases and other encumbrances of the underlying mortgage borrower and the underlying real property. Meaning the mezz owner will only indirectly own the underlying mortgaged property
63 W Legal Background Debt to Equity Swap In the case of Nine Entertainment, they were able to avoid bankruptcy in 2012 after warring lenders agreed on a A$3.3bn debt-for-equity swap that hands control of Channel 9 to two investment groups. Apollo Global Management and Oaktree Capital, which owned about 40% of Nine’s 2.3bn senior debt, offered Goldman Sachs (second-tier lenders) a bigger equity stake in a recapitalised and debt-free Nine (7.5%). In return, Goldman Sachs dropped its demand for warrants in the restructured company. This was subsequent to Goldman Sachs’ original proposal of swapping the mezz debt for 30% equity in Nine. Debt to equity swaps (restructure) from the junior (mezzanine) lender is subject to the senior lender’s approval. However, at the same time, if valuation provides that ‘the value of the company breaks into the mezzanine debt’, aka, the junior lender has an economic interest in the business, the restructure requires consent of the junior lender. This effectively means the mezzanine debt holder also has a leverage against the senior debt owner by barring their ability to restructure their capital structure. Debt to Equity Swap was done by Goldman Sachs and Park Square to take control of Northgate, from owner KKR. This was backed with a 320m leveraged loan financing. Mezzanine Lender’s Leverage against Senior Debt Holder It is arguable that if the senior lenders are able to convince a court that the junior lenders’ debt is out of the money. High Court Justice of England and Wales’ judgment of Bluebrook Ltd in 2009 It was determined that if they had an economic interest, they must be consulted in a Scheme of Arrangements and they must give consent.
64 Outlining population movement in Chicago – Phone Tracking Analysis Overview Using geographic data from twitter, we are able to map out where people congregate in urban centers. • This provides important socio-economic information - as iPhone users earn, on average, 40% more than Android users • This data shows that West Loop (as outlined by the white box) is subject to more foot traffic by higher net wealth individuals than inland Chicago • We can infer that this means that the process of gentrification is nearly complete, establishing long-term demand for real estate and commerce 64
65 Outlining population movement in San Diego– Phone Tracking Overview • From the data, it is clear that iPhone users congregate in the Downtown region • This allows us to infer that there is a high concentration of higher-wealth individuals passing through this area 65
66 Outlining population movement in Los Angeles– Phone Tracking Overview • This map indicates that while Android users are distributed evenly across LA, iPhone user tend to cluster in areas such as the Downtown region • This is indicative of the socio-economic division in LA • It also spotlights the defensibility of the LA office market 66
6767 67 SUBDIVISION 2 – PRECEDENT & SUPPORTIVE TRANSACTIONS
68 W Precedent & Supportive Transactions 2009: Blackstone- purchasing at discount • Blackstone helped Hilton Worldwide restructure substantially all its debt by the purchase and retirement of $1.8 billion debt and the conversion of $2.1 billion of junior mezzanine debt to preferred equity • Blackstone borrowed $13 billion and agreed to take on $7 billion of Hilton’s existing debt. • Blackstone offered to buy back some of the bank debt at a discount • Blackstone negotiated its equity stake in Hilton to 70%
69 W Precedent & Supportive Transactions 2008: Apollo Real Estate Advisors (AREA) – Loan to Own • Africa-Israel Investments and Mann Realty were owners to the Apthorp apartment. • Condo conversion was unsuccessful • Foreshadowing a default, their $135 million mezzanine debt lender AREA and first mortgage lender Anglo Irish Bank threatened to foreclose on the deal. • Owners forced to come up with $23 million in additional equity which lead to the lenders controlling the property and ultimately replacing Mann’s manager
70 W Precedent & Supportive Transactions 2007: Icahn Enterprises – purchasing at a discount - Stratosphere resort was a hotel-casino in Las Vegas facing bankruptcy in 1997 - Icahn purchased Stratosphere’s debt for under 10 cents on the dollar pennies on the dollar and eventually also bought out the minority shareholders for $82 million. - In 2007 Icahn sold the Stratosphere along with neighbouring properties for $1.3 billion.
71 W Precedent & Supportive Transactions 2009: Apollo Management and Oaktree Capital – Loan to Own - Countrywide was UK’s largest estate agency. - In 2007, weighed down by the housing market, it was unable to support its debt load in the long- term - In 2008, Oaktree began purchasing Countrywide’s bonds, up to 34% in the company’s secured bonds. - In 2009, Apollo negotiated with bondholders to discuss a potential debt restructuring and successfully recapitalised the company
72 W Bryant Plaza Research Renovation #1: Underground carparking (WIP Leadership Board Member Michelle Wendler, AIA, is Principal of Watry Design. She has been creating parking solutions for the firm’s clients for more than 24 years. Wendler, a licensed architect in 12 states, is responsible for the design) Assumptions: (Assumptions made from Michelle Wendler, the lead parking designer and structure for Watry Design and a licensed architect in 12 states, is responsible for the design of more than 150 parking projects) The property’s on-site parking of 300 spaces is on land and not part of the building Soil condition of property is suitable and allows for underground car park construction $5000 annum revenue/ stall 135 sf width and length 300-340 sf/ stall $45/sf Plan: Additional 400 spaces as underground parking, this will bring additional $2M/annum Construct 4 underground car parking levels to add 400 parking spots Cost of construction: Average size of car park: 320 sf No. car parks: 400 Price per sf: $450-$550 320sf*400=12,800*45= $5.7M NOI: Car park rent flat rate: $10 No. days per year: 265 No. car parks: 400 $10*365*400= $1.5M Things to consider: Geography: LA Average costs of labor and resources needs to be noted. As well as condition of soil, seismic regions and availability of materials.
73 W Bryant Plaza Research • Number of parking levels: • In general, a larger-footprint parking structure that is shorter will cost less per parking space than a taller structure with a smaller footprint. The cost per square foot of the first level that is on the ground is less than levels that are elevated above the ground. A lower-height, larger-footprint structure will have a higher proportion of the cost in the first level. The taller a structure is the heavier it is, and this affects the foundation cost. A taller structure generally has a less efficient parking layout, which translates into more square feet for each parking space. • • Cost of underground parking: • If a parking structure is one level underground, the cost per square foot can increase by approximately 15%. If the structure is more than one level below the ground, the cost would be approximately 45% higher than the original cost per square foot as cost increases due to impacts of having to dig deeper. • Cost of structural system: • 60% to 70% of the cost of parking is in the structural system. Therefore, the selection of the framing system will have a significant effect on the cost of each parking space. There are two general types of framing layouts and there are different types of structural systems. The two types of framing layouts are short- span and long-span. Short span is where you have a column approximately every three parking spaces (27x30 feet square) to support the floor slab. Long-span is where you have columns spaced 60 feet apart, with beams spanning over the stalls and the drive aisle. Generally, short-span systems cost less per square foot, but the efficiency is not as good. Long-span systems cost more per square foot, but you are getting more stalls in the same square footage. The structural system of a parking structure can be either Cast-in-Place Concrete, Precast Concrete or Structural Steel. Which system is more cost effective depends on the location of the project and the preferred methods of construction in the region. This is a case-by-case analysis. The selection of a system that is not common in the area will generally cause the structure to cost more. • • The foundation system of the car park has a huge impact on cost of structured car parks. • Structures founded in poor soils’ conditions that require more expensive, deeper foundation systems will cost more. The difference between a shallow and deep foundation system can increase the price approximately 10% overall – taking the cost from, say, $50 to $55 per square foot.
74 W Bryant Plaza Research Total car parking spaces The overall size of a project has an effect on the cost per parking space. A smaller project will cost more per space than a larger project. A 200-stall parking structure on a small site may cost about 30% more per square foot than a 1,000-stall structure on a “reasonably” sized lot. Efficiency This is the amount of square footage it takes for every parking stall overall. The cost of a parking space is the cost per square foot times the square foot per parking stall. So, the more square feet you have to build per stall will increase the cost per stall. Market conditions As we have seen over the last few years, the cost of parking can be affected by market conditions. Costs can go both down and up. The swing can be 10% or more. A normal bid market will generate four to six bids from qualified contractors. An aggressive bid market might see 10 or even more bids, some not necessarily from qualified bidders. This will cause the price to decrease but can create concern if the bidders are not qualified. An impacted bid market might see one to three bidders and price increase due to lack of competition.
75 W Bryant Plaza Research
76 W Bryant Plaza Research Assumptions: (Data from U.S Department of Housing and Urban Development) 6 ft fire code safety setback 7% unusable area of roof due to safety setbacks – minus 1283 sf 15% rooftop obstructions- minus 2750 sf Total usable rooftop area= 18333-1283-2750= 14,300 sf (Quote from US-based professional design services firm ‘Cabaret Design Group’) Average cost to build a bar is $200-$300 per sf Average 18’ 6” bar equipment cost: $8,000 Cost of contstuction: Construction cost per sf: $200-$300 per sf Bar equipment cost: $8,000 Total Cost: ($250*14300)-8000= $360,000 Cost: $300,000-$400,000 NOI: $1.8M
77 Appendix – Cutler Center Renovation Comps Overview - Costings • $800M Costing • 1.2M Sqft renovation • Indicative of $667/sqft Westfield Century Centre Returns Analysis • Occupancy expense proportions imply an annualized increase in rental revenue of 50-80m p.a
78 Appendix – Cutler Center Renovation Comps Overview - Costings • $500M Costing • 400K Sqft renovation • Indicative of $1250/sqft Willis Towers Renovation • Willis Tower’s is the tallest building in Chicago • Purchased by the Blackstone Group • Renovation inclusive of five-star restaurants, casual dining options, a 30,000sqft outdoor deck and 50,000swft ‘digital attraction’ • Significantly more expensive than planned cutler renovations
79 Appendix – Cutler Center Renovation Comps Overview - Costings • $1B overall costings • 3M sqft of retail space • Indicative of $340/sqft Union Station Renovation • Union Station is a major inner- city rail hub • Renovation is inclusive of retail, office and administrative space
80 Appendix – Rivers Towers Renovation Comps Overview - Costings • $7M renovation of facilities • Roughly 24,000 square feet renovated • Implies a cost of $290/sqft 701 B St Renovation • 701 B St is a class A office and entertainment space • Renovation was focused on upgrading the lobby, lifts and other shared spaces
81 Appendix – Rivers Towers Renovation Comps Overview - Costings • $500M costing • 2.5M sqare feet • Implies a cost of $200 per square foor Chicago Old Post Office Renovation • The Chicago Old Post office is a major office space • Renovations inclusive of a brand new lobby and rooftop gardens
82 Appendix – Rivers Towers Renovation Comps Overview - Costings • $500M costing • 2M square feet • Implies a cost of $250 per square foot Moscone Center Renovation • The Moscone Center is a major hotel, office and office space • Renovations inclusive of major aesthetic and functional changes
8383 83 APPENDIX DIVISION 3 – RISK 83
84 W Macroeconomic Risks • Unemployment rate • Risk: difficulty in finding suitable tenants • Low unemployment rates may affect our occupancy rate and ability to find tenants when leases rollover • We should find a well-diversified mix of tenants for our office buildings when leases end. Selected tenants should be from growing employment rate sectors such as health & education industry and the financial services industry • However, unemployment rates forecasted to peak in 2010 and then fall steadily • Occupancy and rents forecasted to begin sustainable growth in 2011 • 8.7M jobs were lost during the recession but 7.4M jobs were gained by 2014 during recovery. Six subsectors have accounted for 83.4% of recovered jobs. Professional and business services sector accounting for the most percentage of recovered jobs then Health care and Leisure & Hospitality inudstries • • Chicago: • Metro Chicago economic results have proven unsteady. However, CH has recorded year-to- date growth of more than 31,000 jobs compared to losses of 92,000 from the same period of 2009. Unemployment rate forecasted to drop to 8.1% in coming 3 years (2013) • Economy is expected to go into accelerated expansion especially office jobs sector • Projected positive absorption duelled by drop in rate of sublease additions and increased occupancy rates • Office buildings leased to young social media tech companies • Chicago’s CBD leasing market experienced most activity from small to mid-sized users • Many landlords improved and upgraded their properties to stay competitive by investing in lobby renovations or adding outdoor trances • Chicago CBD has a trend of plug-and-play and on-demand suite availabilities • River North tower a $1.3 m.s.f office building sold for $480 p.s.f (record setting p.s.f pricing in 2010)
85 W Macroeconomic Risks LA: Moderate occupancy rate gains Tenants dominated by law firms and financial services tenants Trend of owners increasingly target a more diverse tenant base, including creative and entertainment companies Westside an established home base for media, technology and mobile industries- these industries are expected to see continued growth and will drive new requirements Increase in competition among tenants for “creative” space has led landlords to increase rental rates- interplay between entertainment and high-tech is significant trend Growing demand for office buildings and sustained growth from existing tech tenants Leisure and hospitality experienced a steep decline due to the recession, but added more than 15,700 LA-based jobs since Jan 2010, driven by an increase in discretionary and business spending San Diego: Leisure and hospitality sector posted the greatest employment recovery- adding 7,000 in 2013 Office-using industries such as professional and business services was one of 7 sectors that saw employment gains Also measured growth in construction Downtown submarket heightened activity- growing demand of tenants in tech sector and projected growth in professional services industries Steady leasing market, transaction volume and sales value in 2010 is forecasted to outpace those seen in past years
86 W Macroeconomic Risks
87 W Tenant Risk Rent Roll quality Refer to credit worthiness, stability and number of tenants Rollover risk refers to remaining term left on leases at a property and it affects both single Delinquency Rate Delinquent loans rising- through 2009 9% of CRE loans in bank portfolios were delinquent, which is more than double of 2008 There has been a significant increase in non-performing commercial real estate in the US since 2008. This period also saw heightened levels of maturities and record levels of outstanding commercial mortgage debt. The total value of distressed commercial real estate was $166.8 billion in 2010, including properties in distress, foreclosure, and lender REO, according to data from Real Capital Analytics Starting June 2010- volume and value of distressed commercial real estate has dropped Delinquency rates has risen steadily over the past two years from 5% in the 4Th quarter of 2007 to 19.0% in first quarter of 2010. Non-accrual rate increased rom 2.9% to 14.6% The commercial mortgage sector’s total delinquency rate grew to 5.5% in the 1st Q of 2010, compared to 5.1% in 4th Q of 2009 and 3.6% one year ago Non-accrual rate is the main factor contributing to coverall growth, accounting for 69% of the total delinquency Bank-held commercial mortgage default rate rose to 4.2% in the 1st quarter 2010 compared to 2.3% the previous year
88 W Tenant Risk Rent growth fastest in CBD Class A offices based on supply and demand coming in close to equilibrium levels
89 W Tenant Risk New supply coming to market is slowly increasing but still well below historic norms New supply coming to market is slowly increasing but still well below historic norms
90 W Tenant Risk
91 W Financing Risk Interest Rate RIsk  Risk that interest rates will increase when we refinance and get a loan from the bank I Debt to Equity Swap Risk of senior lender not giving approval of debt to equity swaps Debt-for-equity swap significantly de-levers the distressed property’s balance sheet Mezz lender faces the risk of a separate foreclosure on pledged equity interests of the borrowing entity. Inter-creditor agreements creating rights and obligations between lenders can also impact the success of lender’s control of the borrowing entity. A mezz lender in foreclosure can significantly change the loan resolution outcome if the mezz lender has a position that is partly in the money or has the ability to bring new money or expertise to the situation. Inter-creditor agreement assumption- E.g. provide that all cash flow be paid on occurrence of a default, to senior note holders interest and principal until the senior debt is fully repaid before any interest can be paid to subordinate holders Upon a borrower’s default, mezz lender’s only commercial alternative is to cure the default by refinancing the secured property or taking out the senior lender at par value. Average mezzanine loans have a default rate of 16.10%
92 W Competitive & Construction Risk Construction Risk Cost overruns May take longer than anticipated to complete Expose previously unknown defects in the physical asset Default of construction company? During post-recession where manufacturing and construction industry suffered the most Tenant improvements are currently averaging 18% of the first year’s least cost for ‘A’ properties
9393 93 APPENDIX DIVISION 4 – VALUATION 93
94 Property & Mezzanine Overview 94
95 Total Projected FCF 95
96 Cutler Centre 96
97 97
98 River Tower 98
99 99
100 Bryant Plaza 100
101 101

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Real Estate Competition - Campus Finalist

  • 1. 11 1 AN ACQUISTION OF THE PORTFOLIO 1
  • 2. 2 Table of Contents 2 2 Strategic Overview3 5 6 7 9 10 11 National Market Overview Portfolio Summary West Loop Summary Cutler Centre San Diego Summary Rivers Tower Los Angeles Summary12 13 14 15 16 17 18 Bryant Plaza Portfolio Recap Valuation Valuation of Debt Valuation of Property Assumptions Recommendations19 20 21 22 23 24 25 Strategic Summary Due Diligence Acquisition of the Loans Debt - Equity Refinancing Renovations Cutler Centre - Upgrades26 27 28 29 30 31 32 Rivers Towers - Upgrade Bryant Plaza - Upgrade Exit & Sale Risk Recap Overview & Summary Expected Returns33 35 36 57 83 93 Appendix Division 1 – Market Research Division 2 – Strategic Research Division 3 - Risk Division 4 - Valuation Summary34
  • 3. 33 After conducting appropriate negotiations and due diligence, we should move to purchase the portfolio at a 75% discount to it’s face value. We should leverage our lein against the borrowers equity and our capacity to limit investor losses to convert out mezzanine loans to a proprietary interest in the properties We should renovate all three properties to maintain the Class A classification of the properties. We are pursuing a minimum multiple on equity of 2.5x. Our model indicates that the portfolio will return a levered IRR of 22.28% and a levered equity multiple of 4.11x This exceeds the needs of Sun Rock Capital’s fund. Expected Returns Strategic Overview SWAPACQUIRE RENNOVATE 3 We believe that we will be in the end of a strong bull real estate market in 2018. Thus, we should sell them SELL The current downturn in global real estate market conditions creates the opportunity for us to purchase quality Real Estate assets at a substantial objective discount. Investment Thesis 3 We recommend pursuing loan-to-own strategy consistent with the funds targeted returns and overall strategy
  • 4. 44 4 PORTFOLIO & MARKET OVERVIEW – BUILDING AN ECONOMIC NARRATIVE 4
  • 5. 5 • GFC-driven Yield spikes appear to have ended • Research into the principles of mean reversion suggest yield will compress slowly over the coming decade Expected Growth Rates Yield Trends US Property Market Overview • The recent decline in global market conditions has caused a substantial shift in the commercial real estate industry • Interest rates are at all an time low – 0.25% • Commercial prices are currently sitting at 2002- 2003 prices. • The current interest rate environment is expected to cause a gradual decrease in yields over the coming 5-10 years 0.0 20.0 40.0 60.0 80.0 100.0 120.0 1997-12-01 1999-12-01 2001-12-01 2003-12-01 2005-12-01 2007-12-01 2009-12-01 Green Streets - Commercial Property Price Index • Investors expect rent to grow at an increasing pace • In the short term, it appears that rent growth will be outstripped by expense growth and inflation 0.00 2.00 4.00 6.00 8.00 10.00 12.00 14.00 US Delinquency Rates • Loan Delinquency rates appear to have peaked mid- 2009 • We expect rates to decrease slowly in line with current interest rate conditions Our analysis indicates that equity offers better long-term risk adjusted returns than debt 5
  • 6. 6 A portfolio in context… • The fund has diversified its holdings well across major American cities • This limits our exposure to localised disaster and regional economic volatility Geographic Diversity The global financial crisis has forced us to target a minimum MOI of 2.5x • 67% of used capital has been deployed to purchase equity • Current market conditions imply that a weighting towards equity is best practice Investment Vehicle Office 52% Industrial 13% Hotel 16% Retail 19% • Office buildings are less sensitive to macroeconomic conditions than retail or hotels • This allows them to act as a relative hedge to current financial volatility Building Kind • 4 properties are expected to make a loss • This means that, in order to meet the portfolio target MOI of 2x, the remaining capital must be invested at at least 2.5x Projected MOI 67% Capital In Equity 1 3 1 3 1 2 1 <0.5 <1 <1.5 <2 <2.5 <3 <3.5
  • 7. 7 • West Loop is a former industrial center that has experienced a significant degree of urban gentrification • It’s central geographic position creates an opportunity for high reach retail businesses such as bars and restaurants • The decline of many of Chicago’s outer suburbs creates substantive demand for high-wealth, developed inner-city property West Loop West Loop – A growth centre… The West Loop submarket is a substantial growth pocket that persists despite Chicago’s poor economic performance 4000000 4100000 4200000 4300000 4400000 4500000 4600000 4700000 4800000 Chicago Historical and Projected Unemployment Data - 2007-2011 Consumer 17% Services 28% Manufacturin g 14% Construction 41% Chicago Industry 1641 935 855 730 622 520 494 487 New York LA Chicago DC Dallas Atlanta Houston San… Business Service Employers (‘000)
  • 8. 8 Copernicus Landsat 1984 West Loop - Growth and Development Trends Copernicus Landsat 2010 We believe the fundamental geographic characteristics of the West Loop submarket will drive intrinsic demand growth. A comparison of satellite imagery shows that the developmental boundaries of Chicago have expanded 200-300% over the past 25 years. This city growth is a strong driver of demand for centralised real estate assets.
  • 9. 9 5400000 5600000 5800000 6000000 6200000 6400000 6600000 6800000 7000000 7200000 2011 2012 2013 2014 2015 2016 2017 2018 W Location: West Loop Cutler Centre • Cutler Centre is a 15-storey Class A office tower located in the West Loop submarket of Chicago. • 240,000 square feet of office space consisting of well-diversified mix of tenants. – 82% occupancy rate in office – Currently in line with market, but was below- market last year • 10,000 square feet of street-level retail space consisting of the Bank of America, convenience store, and clothing boutique. – 100% occupancy rate – Entire rental contract rolls over in 2018 • Rent roll unknown • Loan structure consists of a senior loan and two mezzanines Property Overview SUMMARY Cutler Towers can act as a lever to access growth in the growing West Loop submarket NOI Projections
  • 10. 10 • San Diego has been considered a leading area to launch a company • San Diego is enclosed by the Laguna Mountain Range. This creates a premium for downtown real estate. • San Diego has been designated a Foreign Trade Zone. This creates opportunities to leverage global trade trends • Property sales reached an all time low of 2,142 in January 2008 • Currently, sales sit at around 3000 – substantially lower than the historical mean of 4,000-4,500 • Auction success rates are at an all time low Downtown San Diego Downtown San Diego – Dense development San Diego Property Sales 2000-10 0% 20% 40% 60% 80% 100% 120% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Auction Success Rates 2000-10 We can capitalize on poor market conditions to ride San Diego’s growing technology and trade industries
  • 11. 11 6400000 6600000 6800000 7000000 7200000 7400000 7600000 7800000 8000000 2011 2012 2013 2014 2015 2016 2017 2018 W Location: Downtown San Diego Rivers Tower • Rivers tower is a 20-storey Class A office tower located in the San Diego CBD. • 500,000 square foot of office space consisting of a diversified tenant mix – 75% occupancy rate – Below-market • No major capex has been invested and no major renovations have been made • Rent roll unknown • Loan structure consists of a senior loan and two mezzanines Property Overview SUMMARY Rivers Tower will give us access to the Downtown San Diego submarket NOI Projections
  • 12. 12 • The Los Angeles Property Market appears to have bottomed out • Trade volumes, a major driver of LA economic activity, are at 2003 levels • Commercial yields have fallen by over 2% over the past two years • There has been a substantial drop in the volume of Real Estate transactions across the city • This indicates that liquidity has dried up substantially over the past 1-2 years • We can leverage this in our debt- equity swap • This will also allow us to ride the inevitable economic recovery Downtown Los Angeles Los Angeles – Leveraging a global trade fulcrum 0 2 4 6 8 10 12 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Volume(MillionTEU) Port of Los Angeles Trade Volumes - 1990-2020 Poor Real Estate performance creates an opportunity to capture recovery-linked growth Los Angeles Commercial Yields Sales Volume
  • 13. 13 3700000 3800000 3900000 4000000 4100000 4200000 4300000 4400000 4500000 4600000 4700000 2011 2012 2013 2014 2015 2016 2017 2018 W Location: Downtown San Diego Bryant Plaza • Bryant Plaza is a 15-storey Class A office tower located in downtown Los Angeles. The building enjoys excellent visibility and contains 300 on-site parking spaces. • 275,000 square foot of office space occupied by varied tenant groups – 75% occupancy rate – Below-market • Building has undergone a significant renovation in 2000. • Loan structure consists of a senior loan and a mezzanine loan Property Overview SUMMARY Bryant Plaza will give us access to the Downtown Los Angeles submarket NOI Projections
  • 14. 14 • Real Estate market cycles typical cycle over between 7-11 years • The last cycle ended in 2008-2009 • The portfolio could act as a vehicle to leverage this trend Fitting the portfolio together… Economic Recovery Market Cycles MARKETS West Loop Increasing Rent & Yields If purchase at the right price, the Portfolio may allow us to ride and profit from a global economic recovery San Diego Increasing Rent & Yields Los Angeles Increasing Rent & Yields US Property Market Cycles
  • 16. 16 W Valuation of the portfolio: Debt Instruments We should purchase the debt instruments at a 75% discount to their implied value Rivers Tower $30,851,197 Discount: 70.00% Purchase Price: $9,255,359 Cutler Centre $20,776,748 Discount: 70.00% Purchase Price: $6,233,024 Bryant Plaza $55,334,228 Discount: 90.00% Purchase Price: $5,533,423
  • 17. 17 W Valuation of the portfolio: Underlying Properties Performing a debt to equity swap would allow us to access the underlying value of these properties
  • 18. 18 CAPITALISATION RATESGROWTH RATESDiscount Rate 9 9 9We have calculated a 9.85% discount rate Our rental growth rates are predicted to grow 2-3% p.a. We predict a 0.4% decline in cap rates per year, leading to an exit cap rate of 5.55% Assumptions Discount Rate Assumptions: Loan Start Date: 01-June-2007 Loan End Date 01-June-2012 Discount Rate: 9.85% 10 Year US Treasury Rate: 3.85% Real Estate Risk Premium: 6.00% Rental Growth Rates Assumptions: Cutler Center 1.2% Post-Capex 3% Rivers Tower 2% Rivers Tower Post Capex 3.85% Bryant Plaza 2% Bryant Plaza Post Capex 3% as the CRE equivalent of the price/earnings ratio in the stock market (see Campbell and Shiller 1988 for the pricing implications of these valuation measures). According to theory, this rent/price ratio is largely a function of interest rates and expected increases in the property’s price. Consider someone who wants to use a real estate property for one year. This person can get the space in two ways. He or she could rent the property for the year, which would cost a year of rent. The rent would appear as part of the property owner’s net operating income. Alternatively, the person who wants to use the property could borrow money, buy it, and hold it for a year. The cost of this ownership option, referred to as the user cost, consists of interest payments on the purchase loan plus the expected change in the property’s price over the holding period. In a well-functioning market with zero transactions costs, the price of these two alternatives should be the same. If they were not—if rents were higher than the user cost, for example— then all market participants would want to buy, bidding up prices until the rental option cost the same. The important point here is the direct link between the net operating income of the rental option and prices, ownership costs, and expected capital gains of the ownership option. When purchasing CRE, market participants often link cap rates to expected future rental rates and vacancies. Expected increases in rent or lower vacancies tend to lower the cap rate. If rents are expected to increase, then the property has become more valuable and the owner will expect a higher capital gain, which will lead to a lower cap rate. A similar argument can be made for falling vacancies. Thus, expected price appreciation is ultimately a reflection of the outlook for fundamentals such as rents and vacancies. However, there could also be unidentified nonfundamental reasons for changes in expected price appreciation. For example, investor sentiment may improve and the discount rate applied to cash flows from a property may fall, thereby lowering the cap rate. Indeed, investor sentiment could become so exuberant that a bubble could form, in which expected appreciation soared and the cap rate dropped sharply. This link between cap rates, interest rates, and expected price appreciation is not merely theoretical. Using a slightly different representation of the cap rate, Ghysels, Plazzi, and Valkanov (2007) show that it predicts CRE returns. In our data we can see these linkages in Figure 2, which compares CRE cap rates with the interest paid on loans to finance CRE transactions. We focus here on the office market, but other CRE asset classes have behaved similarly. Ideally, the interest measure should be the rate on new CRE loans, but those are not readily obtainable. Instead, we use as a proxy for CRE purchase loans the yield on AAA-rated five-year commercial mortgage-backed securities (CMBS), which finance a large share of CRE transactions. Figure 2 Office building cap rates and CRE mortgage rates Sources: CB Richard Ellis (CBRE) and Commercial Real Estate Direct. 0 1 2 3 4 5 6 7 8 9 10 0 2 4 6 8 10 12 14 16 18 20 2004 2005 2006 2007 2008 2009 2010 2011 Percent Percent CMBS yield (left axis) Office cap rate (right axis) Summer 2010 Our valuation is driven by a 9.85% discount rate, a 2-3% rent growth rate and a 0.4% Cap Rate compression each year
  • 20. 20 Strategic Summary We propose purchasing the debt, swapping it to equity, renovating the properties and exiting at the peak of the market in 2018 • Conduct due diligence:  Property Condition  Owner’s Equity  Any binding agreements between HRC Capital, senior debt holders and owner • Negotiate an interparty agreement between owner  Debt to Equity swap for the ownership interest in the property is viable Due Diligence Interparty agreementPrior to Acquisition • Purchase all Mezzanine offered at a 75-90% discount to its value • Conduct a Debt to Equity swap Purchase Mezzanine Debt • Owner will most likely default in payments  Senior debt will be compensated, but mezzanine debt may not be  We will not get our money back • Do not pursue investment any further Do not Purchase Mezzanine Debt SWAP • Refinance the senior debts at a lower interest rate • Renovate the office buildings to -  Suit changing contemporary economic conditions  Appreciate underlying value Occupy Ownership Interest of the Properties Owner DefaultsBuy or Pass Exit Strategy Contingencies SELL • Exit each office building in year for a total of $311M • Offering a levered IRR of 22.8% Exit the Office Buildings 2010-2018
  • 21. 21 Borrowe r Senior Debt Mezz Debt Senior Debt Mezz Debt Senior Debt Bryant Plaza Cutler Centre Rivers Tower Is the purchase of the mezzanine loans UCC (Uniform Commercial Code) approved? Negotiations and Due Diligence Questions Will inter-creditor agreements interfere with either the purchase of the loan or the Debt-Equity Swap? What upper-level debt agreements are the properties subject to? What senior mortgage covenants and restrictions is the property subject to? Is the borrower willing to swap the mezzanine loans for an equal proprietary interest in the building? Do the terms of the current capital structure allow for us to refinance immediately? Due Diligence & Negotiations We need to run a number of meetings and operate several due diligence checks before we proceed further… 2010 Due Diligence Checklist Property & Markets Borrower Position Legal Structure & Documents Other Creditors Servicing History
  • 22. 22 Acquiring the loans… The debt on the portfolio matures after the next interest payment, thus there is a clear need to refinance 2010 CUTLER CENTRE ACQUISITIO N • Targeting a 70% discount to the implied, risk free value of the loan. • Reflective of the fact that the loan will default as the property and capital structure are distressed • The fulcrum position of the loan with respect to the capital stack as a whole should allow us to pursue this discount PURCHASE PRICE: $6.2M RIVERS TOWER ACQUISITIO N • Target an identical 70% discount to the implied risk free value of the loan • Reflective of similar conditions to the Cutler Centre PURCHASE PRICE: $9.3M BRYANT PLAZA ACQUISITIO N • Bryant Plaza’s NOI is two times lower than their debt service requirements • Therefore it is the most distressed out of all three properties • Thus, we are targeting a 90% discount to the implied, risk free value of the loan. PURCHASE PRICE: $5.5< THE PORTFOLIO ACQUISITIO N • Overall, we are targeting a weighted discount of 75.26% • This is the minimum discount required to meet the 20% IRR requirement set out by Sun Rock Capital PURCHASE PRICE: $21M
  • 23. 23 Performing a debt to equity swap By nature, mezzanine debt is a more effective vehicle for pursuing loan-to-own strategies • Mezzanine are more flexible than senior debt • A debt-equity swap would avoid the borrower public embarrassment • Mezzanine debt cause a great deal of anxiety among borrowers for the following reasons • Mezzanine Debt commands a higher interest rate than senior debt, therefore it has a higher chance of default • If a borrower defaults on a mezzanine loan, the lender foreclose on the equity of the borrower rather than the property • Estimates of cash flows indicate the borrower will default on their next interest payment • This will allow the holder of the mezzanine to foreclose on the equity of the borrower • As a result, a default would be catastrophic for the borrower • A debt to equity swap would allow the borrower to avoid this issue PERSUASIVE FACTORS LEVERAGE TERMS OF SWAP TERMS • We will swap our mezzanine debt at 1:1 ratio, i.e. 1% debt is converted into 1% equity • We will take on the current obligations subject to the property and owed to senior and other mezzanine debt holders • We will take management of the property in all areas, such to indicate that we are the sole equity partner and owner of the properties Borrower Senior Debt Mezzanine Loan1 Mezzanine Loan 2 Senior Debt Mezzanine Loan1 Owner (Sunrock Capital) 2010
  • 24. 24 Refinancing the loans The debt on the portfolio matures after the next interest payment, thus there is a clear need to refinance 2010 CURRENT CAPITAL STRUCTURE CONDITIONS Capital Structure Of Properties: Cutler Center - Chicago Senior Loan: $35,000,000 First Mezzanine: $30,000,000 Second Mezzanine: $20,000,000 Rivers Tower - San Diego Senior Loan: $57,000,000 First Mezzanine: $25,000,000 Second Mezzanine: $30,000,000 Bryant Plaza - Los Angeles Senior Loan: $45,000,000 Mezzanine: $51,000,000 Cutler Centre – Refinanced Capital Structure & Conditions Senior Loan: Principal: $35,000,000 Loan Term (Years): 10 Rate: 4.50% Amortisation (Years): 30.00 Payment: $2,148,704 First Mezzanine: Principal: $30,000,000 Loan Term (Years): 7 Rate: 12.00% Amortisation (Years): IO 7 Payment: $3,600,000 Rivers Tower – Refinanced Capital Structure & Conditions Senior Loan: Principal: $57,000,000 Loan Term (Years): 10 Rate: 4.50% Amortisation (Years): 30.00 Payment: $3,499,318 First Mezzanine: Principal: $25,000,000 Loan Term (Years): 7 Rate: 12.00% Amortisation (Years): IO 7 Payment: $3,000,000 Bryant Plaza – Refinanced Capital Structure & Conditions Senior Loan: Principal: $45,000,000 Loan Term (Years): 10 Rate: 4.50% Amortisation (Years): 30.00 Payment: $2,762,619 Loan Structure TARGETED CAPITAL STRUCTURE STRUCTURE We are targeting a 4.5% fixed interest rate for senior debt. This is derived from similar loans at the time, and the competing impact of low interest rates and poor macroeconomics We target a 12% fully amortized structure for mezzanine loans. This will compensate investors for the risk they are taking.
  • 25. 25 Renovation as a defensive strategy… Renovation is necessary as a defensive move to lock in the Portfolio’s value in the heat of a strong bull market 2018 Renovation Rationale MARKET TRENDS STRUCTURE • As value and liquidity returns to the market, competition will follow • There will be strong growth in the number and value of new property projects • In order to be competitive in this environment, we need to keep our property up to date CONSUMER TRENDS STRUCTURE • At the peak of the market, there will be a set of consumer demands which will become standard for Class A properties • We must ensure that our properties are sufficiently equipped to meet the demands of both tenants in purchasers in 2018 BUILDING CLASSIFICATION STRUCTURE • If we do not ensure sufficient Capex, it is possible several properties may be downgraded to Class B
  • 26. 26 Cutler Centre – Creating a luxury entertainment space… The retail space in the Cutler Centre can be renovated and upgraded to leverage market cycles We propose upgrading and reconfiguring the 10,000sqft of retail space, with the following proportions of rental space in mind; • 40% of rental space dedicated towards formal luxury dining – This establishes a convenient platform for office tenants to use as a meeting and entertaining space • 40% of rental space dedicated towards casual dining – This leverages the catering needs of office space tenants • 20% of rental space dedicated towards a bar or other licensed facility – This helps meet the entertainment and social needs of tenants Luxury Entertaining UPGRADE An analysis of large scale retail space renovations indicates an average cost of between $340-1200 sq ft. We believe our renovations will cost roughly $5M Costings EVALUATION Measuring Return RESULTS 2013-2014 26 3% Post Value Add Growth Rate 1-1.5% Decrease in exit Cap Rate
  • 27. 27 Rivers Tower – Stronger communities… Updating shared spaces within the River Tower will drive down exit yields while increasing NOI We propose renovating the estimated 24,000 square feet of lobby and shared space in Rivers Tower. This will be critical to decreasing the vacancy rates, increasing rates and compressing exit yields • As we are aiming to sell at the peak of the market in 2018 , we believe it is critical to ensure the building is designed well – As such, we have allocated capital towards graphic design and architecture Lobby & Shared Space Upgrades UPGRADE An analysis of large scale office space renovations indicates an average cost of between $200-300 sq. ft. We believe our renovations will cost roughly $6M. Costings EVALUATION Measuring Return RESULTS 2013-2014 27 Post Value Add Growth Rate 1-1.5% Decrease in exit Cap Rate 2% 4.9-7M Value Add
  • 28. 28 Bryant Plaza – Changing the platform We can elevate Bryant Plaza’s value by changing the way space is utilized and leveraging it’s geographic position We are proposing two major changes to Bryant Plaza Rooftop Bar • The excellent views offered by Bryant Plaza create the opportunity for us to build a rooftop bar • This would drive up rent in 2018-19, increasing the sale price Underground Carpark • Bryant Plaza’s access to motorways creates an opportunity to generate excess cash returns • The Los Angeles population uses cars heavily Parking & Bars UPGRADE An analysis of large scale retail space renovations indicates an average cost of between $450 sqft. We believe our renovations will cost roughly $6M Costings EVALUATION Measuring Return RESULTS 2013-2014 Generates 1.8 extra revenue per annum Present Value of 6.8M
  • 29. 29 Exiting the position - Selling and Profiting… The debt on the portfolio matures after the next interest payment, thus there is a clear need to refinance 2018 5.5% Target Exit Cap Rate 311.4 USD Exit River Tower 125.7M USD Bryant Plaza 74.6M USD Cutler Center 111M USD 130M USD Levered Free Cash Flow in Year 8 WHY SELL IN 2018? Market Cycles Our analysis indicates that the market will peak between 2017 and 2020. In order to be conservative and avoid mistiming the market, we believe 2018 is strong target sale period Capitalization Rates We believe the current interest rate environment will persist in general terms for the next decade This, along with the general economic recovery, will compress capitalisation rates and thus increase our sale price
  • 30. 30 Increasing Likelihood IncreasingImpact Strategic Failure Macroeconomic Challenge Tenant Risk Matrix Overview: Commercial properties are sensitive to market conditions. Due to the post-recession environment, unemployment rates and US office market vacancy rates has increased steadily across the nation. We believe these factors may impact our ability to find quality tenants when rents rollover in 2012. Overview: Delinquency rates of commercial real estate loans are rising rapidly and the market currently holds record levels of outstanding commercial debt mortgage. Rent growth and net absorption has also experienced declines. We believe these factors proposes a risk of tenants’ default on lease repayments or loans. Overview: We believe we will be exposed to interest rate risks when we refinance our loans. Additionally, the presence of Mezzanine loans on two of the properties, which will lein on SunRock, need to managed carefully. Strategic Risks Overview: Exposure to senior debt risk. Construction and renovation risks due to impacted construction industry. Macroeconomic Risk Tenant Risk Financing Risk Strategic Risk Financing Failure Analysing Risk… The debt on the portfolio matures after the next interest payment, thus there is a clear need to refinance
  • 31. 31 Recapping our strategy We believe that performing a debt to equity conversion will allow us to deliver results in line with our portfolio’s needs 21M USD Purchase Equity Injection 17M USD 130M USD Free Cash Flow Exit 27M USD After conducting appropriate negotiations and due diligence, we should move to purchase the portfolio at a 75% discount to it’s face value. We should leverage our lein against the borrowers equity and our capacity to limit investor losses to convert out mezzanine loans to a proprietary interest in the properties We should renovate all three properties to maintain their class A classification. SWAPACQUIRE RENNOVATE We believe that we will be in the end of a strong bull real estate market in 2018. Thus, we should sell them SELL
  • 33. 33 Valuing our returns We believe that performing a debt to equity conversion will allow us to deliver results in line with our portfolio’s needs Cutler Centre – West Loop, CH Bryant Plaza, Downtown, LA Rivers Tower – Downtown, SD The PortfolioProperty Returns Unlevered IRR: 63.20% Unlevered Equity Multiple: 13.70 x Levered IRR: 22.69% Levered Equity Multiple: 4.55 x Property Returns: Unlevered IRR: 48.12% Unlevered Equity Multiple: 9.28 x Levered IRR: 25.94% Levered Equity Multiple: 4.41 x Return Metrics Unlevered IRR: 55.96% Unlevered Equity Multiple: 11.47 x Levered IRR: 22.28% Levered Equity Multiple: 4.11 x 130M Levered Sale 27M Free Cash Flow Equity (excluding sale) 48M Levered Sale 6M Free Cash Flow Equity (excluding sale) 47M Levered Sale 2.68M Free Cash Flow Equity (excluding sale) 35.6M Levered Sale 17M Free Cash Flow Equity (excluding sale) Property Returns: Unlevered IRR: 56.61% Unlevered Equity Multiple: 11.53 x Levered IRR: 19.06% Levered Equity Multiple: 3.56 x
  • 34. 34 Recapping our presentation We believe that performing a debt to equity conversion will allow us to deliver results in line with our portfolio’s needs Acquisition and Due Diligence Debt- Equity Swap Holding & Renovation Sale & Exit Due Diligence Checklist Property & Markets Borrower Position Legal Structure & Documents Other Creditors Servicing History 21M Portfolio Purchase LEVERAGE We believe that our claim against the borrowers equity and said borrowers poor financial position will persuade the borrower to accept our DIL Persuasive Factors UPGRADES Renovations are necessary as a defensive move to ensure that the property remains Class A and can fully capture the economic recovery Defensive Renovations BEGINNINGS RETURNS Expected Returns Return Metrics Unlevered IRR: 55.96% Unlevered Equity Multiple: 11.47 x Levered IRR: 22.28% Levered Equity Multiple: 4.11 x
  • 36. 3636 36 APPENDIX DIVISION 1 – MARKET RESEARCH 36
  • 37. 37 W US Property Market Information CRE Index • Moodys/REAL commercial property price index • (CPPI) is based on actual repeat sales of a large sample of CRE properties • Transaction-based index (TBI) also uses sales prices, but employs a different index methodology and a smaller property sample. • Figure 1 shows the behaviour of the aggregated all-properties CPPI and TBI indexes from 2004 and 2011 properties, is about $11 trillion, according to the U.S. Commerce Department’s Bureau of Economic Analysis. That compares with an estimated $17 trillion in the total value of residential structures in the United States. Given the size of the market for commercial real estate (CRE), it is important to understand CRE price movements. The Massachusetts Institute of Technology Center for Real Estate publishes two widely used CRE price measures. The Moodys/REAL commercial property price index (CPPI) is based on actual repeat sales of a large sample of CRE properties. The transaction-based index (TBI) also uses sales prices, but employs a different index methodology and a smaller property sample. Figure 1 shows the behavior of the aggregated all-properties CPPI and TBI indexes from 2004 to 2011. From the second quarter of 2007 through the fourth quarter of 2009, both indexes dropped sharply, with the CPPI falling 41% and the TBI 39%. However, since the beginning of 2010, these indexes have been painting very different pictures. The CPPI indicates that, since the end of 2009, CRE prices have slid 7%. But the TBI indicates that CRE prices have actually risen 19% over that period. This unusual deviation in these two indexes raises the questions of whether CRE prices are currently recovering and how prices are likely to behave going forward. To explore what may happen to these prices, we consider the capitalization rate, or cap rate for short, as an alternative indicator of CRE valuations. Figure 1 Two measures of commercial real estate prices Sources: Moodys/MIT Center for Real Estate. Both indexes are based on “all properties.” 50 60 70 80 90 100 110 2004 2005 2006 2007 2008 2009 2010 2011 Index CPPI TBI
  • 38. 38 W Situational Overview Context Current date and location: North America Jan 1 2010 Unemployment topped 10% at end of 2009 Central business district offices fell about 53% from 2007 levels – this class is closely related to unemployment and hiring trends Market may bottom out in 2010 – office vacancies touching 19% - any recovery for offices dependent on jobs Some areas weathered the downturn better than others – location is important – focus on locations with educated workforces, strong population growth, prevalence of desirable industries such as IT Deal activity going forward to be focused on modern, well leased, stable cash flow, well positioned assets – outside these markets, recovery will lag for some time Overall delinquency rate (number of loans with delinquency payments/total number of loans held) has more than doubled since Aug 2008 Loans on properties in secondary markets are delinquent at about 2x the rate of those loans on primary market properties Investor profile SunRock Capital – opportunistic, global real estate investment management company Core (Core plus): least risky because often target stabilised, fully leased, secure investments in core markets; well kept and require no improvements by owner; usually warrants low leverage acquisitions Value add: seek to increase cash flow over time by making improvements to or reposition property; medium to high leverage used to acquire Opportunistic: require significant rehabilitation; usually fully vacant upon acquisition or need to be developed from the ground up; offer highest level of return if successful; bears most risk as property has no in-place cash flow; usually high leverage acquisitions HQ in NYC Past strategies: high yield superior risk adjusted returns; significant renovations of properties, foreclosures (loan to own scenarios – acquisition of secured debt position to influence control and ultimately acquire ownership of target); asset repositioning where relevant Most recent fund – SRC Capital VI Closed in Q1 2009 with $1.5b in equity from pension funds, endowments, sovereign wealth funds, HNW individuals Target gross returns of 20% IRR and 2x equity multiple on investment MOI – multiple on investment
  • 39. 39 W Situational Overview The opportunity Off market opportunity with another real estate private equity fund (HRC Capital) Opportunity: Buy a portfolio of 3 loans on class A office buildings in 3 different North American cities Classes reflect different risk and return – graded on location, physical characteristics, tenant levels, rental income etc. Class A = highest quality building in the area and market; generally newer properties built within the last 15 years with top amenities, high income earning tenants and low vacancy rates; well located in the market and typically professionally managed; typically demand highest rent with little or no deferred maintenance issues While HRC waits for our response, the loans will move between 60-90c on the dollar Each loan is at the fulcrum point in the capital stack of the corresponding property Capital fulcrum point – measures the annual % growth rate required from the underlying instrument for you to do equally well in terms of capital appreciation from its associated warrant (security that entitles the holder to buy the underlying stock of the issuing company at a fixed price called exercise price until the expiry date); the indifference point between buying a warrant rather than the stock in a company Warrants are derivative instruments, are dilutive (Receive new stock when exercised), do not pay dividends or come with voting rights; traditional warrants are issued with bonds ALL LOANS MUST BE PURCHASED IF THE DECISION IS BUY
  • 40. 40 W Situational Overview Portfolio & asset history Loans originated from part of a larger office portfolio acquisition at the peak of the market in 2007 Sponsor expected to find easy refinancing for the Class A, iconic assets when loans matured in mid-2012, given the properties’ (now aggressive) underwriting and assumed steady property market increases Properties are geographically dispersed Portfolio relatively uniform in quality The 3 buildings backing the loans are of a representative quality Loans organised in complex structure Debt was split and syndicated to multiple parties, including CMBS and mezzanine debt holders Commercial mortgage backed securities (CMBS) – type of MBS secured by mortgages on commercial properties. CMBSs are a group of commercial loans on properties such as apartment complexes, factories, office buildings etc. that are bucketed into various tranches (usually 3-4). Tranches are ranked from senior (highest quality) to lowest quality Mezzanine debt - occurs when a hybrid debt issue is subordinated to another debt issue from the same issuer. Mezzanine debt has embedded equity instruments attached, often known as warrants, which increase the value of the subordinated debt and allow greater flexibility when dealing with bondholders; enables firm to gain capital without offering any collateral, if business defaults on the loan, the lender can convert its loan into an ownership stake using options or warrants built into the deal; charges higher interest rate (usually 15-18%) due to lack of due diligence, higher risk and is subordinate to higher forms of debt; The value of the warrant is a floating number based on the future value of the company Mezzanine debt v senior debt: Mezzanine debt is a hybrid form of capital that is part loan and part investment. Senior debt is a loan from a bank. There are many differences between the two. Banks lend off of asset values so most senior loans are collateralized with assets. The bank loan is always secured and in the first position. Mezzanine debt is not collateralized by assets and is usually in the second position with assets. Mezzanine loans are made against the cash flow, not the assets of the business. Because of this feature, mezzanine debt providers use different criteria than banks in qualifying borrowers. They look closely at their EBITDA, their EBITDA margins, and the strength of their historical cash flow. When market declined and office portfolio didn’t perform to underwritten projections, delinquencies weighed on the 3 loans in the portfolio Sponsor worked with lenders on several strategies to consolidate loans and get them out of delinquency After successfully bringing the loans up to date, holder of mezzanine pieces (HRC Capital) decided to market the loans HRC offered a potential off market deal to SunRock before bringing the opportunity to more investors HRC (the borrower) is an established private equity fund – specialises on owning and operating office assets across US (bulk of portfolio in top quality assets in major urban markets such as NYC and WDC)
  • 41. 41 W US Property Market Information • The Federal Reserve left the target range for its federal funds rate unchanged at 1 percent to 1.25 percent during its July 2017 meeting and said it will start reducing its USD 4.5 trillion portfolio relatively soon. • The committee considered near-term risks to the economic outlook as roughly balanced, but said it will closely monitor inflation • Interest Rate in the United States averaged 5.78 percent from 1971 until 2017, reaching an all time high of 20 percent in March of 1980 and a record low of 0.25 percent in December of 2008.
  • 42. 42 W US Property Market Information Capitalisation Rates • If rents are expected to increase  property has become more valuable  owner will expect a higher capital gain lead to a lower cap rate • During GFC, CRE prices dropped about 40% and the market for financing CRE transactions was severely disrupted, resulting in very high CMBS yields. • Since summer 2010, yields on highly rates CMBS have increased about 0.30%. However, cap rates have come down 0.50%. – Decline in cap rates despite the slight increase in interest rates suggest that investor expectations for CRE price appreciation have strengthened has become more valuable and the owner will expect a higher capital gain, which will lead to a lower cap rate. A similar argument can be made for falling vacancies. Thus, expected price appreciation is ultimately a reflection of the outlook for fundamentals such as rents and vacancies. However, there could also be unidentified nonfundamental reasons for changes in expected price appreciation. For example, investor sentiment may improve and the discount rate applied to cash flows from a property may fall, thereby lowering the cap rate. Indeed, investor sentiment could become so exuberant that a bubble could form, in which expected appreciation soared and the cap rate dropped sharply. This link between cap rates, interest rates, and expected price appreciation is not merely theoretical. Using a slightly different representation of the cap rate, Ghysels, Plazzi, and Valkanov (2007) show that it predicts CRE returns. In our data we can see these linkages in Figure 2, which compares CRE cap rates with the interest paid on loans to finance CRE transactions. We focus here on the office market, but other CRE asset classes have behaved similarly. Ideally, the interest measure should be the rate on new CRE loans, but those are not readily obtainable. Instead, we use as a proxy for CRE purchase loans the yield on AAA-rated five-year commercial mortgage-backed securities (CMBS), which finance a large share of CRE transactions. Figure 2 Office building cap rates and CRE mortgage rates Sources: CB Richard Ellis (CBRE) and Commercial Real Estate Direct. 0 1 2 3 4 5 6 7 8 9 10 0 2 4 6 8 10 12 14 16 18 20 2004 2005 2006 2007 2008 2009 2010 2011 Percent Percent CMBS yield (left axis) Office cap rate (right axis) Summer 2010
  • 43. 43 W US Property Market Information Terminology: Net Absorption: Absorption is the amount of space or units leased within a market or submarket over a given period of time (usually one year). Absorption considers both construction of new space and demolition or removal from the market of existing space. It represents the demand over a specified period, contrasted with supply. When supply is less than demand, vacancy decreases and absorption is positive. When supply is greater than demand, vacancy increases and absorption is negative.
  • 44. 44 W Chicago Property Market Information Overall, the CBD remains a landlord’s market as rent continues to increase across all building classes and fewer concessions are granted. Limited availability of quality high-rise space coupled with continued corporate migration into the CBD has solidified an advantageous environment for landlords; however, tenants in a position to open negotiations with landlords in 2017 will be looking at a more tenant favourable market as approximately 2.3 million square feet are delivered in early 2017. As this space is delivered to the market, landlords will seek to avoid losing tenants to the new developments, which will likely increase concessions granted to tenants. Investors see value in Chicago’s assets as they offer a significant discount in pricing relative to comparative properties on the coasts and believe Chicago’s diverse economy and talented workforce make for strong investments.
  • 45. 45 W Chicago Property Market Information • From 2009 – 2015, the vacancy rates have continually dropped – Total decline of 3.8% • Period 2009 had a net absorption of - 1,614,937 – Oversupply of office properties • Can be explained by the effect of the GFC that caused a loss of jobs, a decline in real income, a slowdown in industrial production and manufacturing and a slump in consumer spending • From 2010 – 2011, economy began to recover as vacancy rates declined and net absorption levels became positive again.
  • 46. 46 W Chicago Property Market Information • From 2009 – 2015, the vacancy rates have continually dropped – Total decline of 3.8% • Period 2009 had a net absorption of - 1,614,937 – Oversupply of office properties • Can be explained by the effect of the GFC that caused a loss of jobs, a decline in real income, a slowdown in industrial production and manufacturing and a slump in consumer spending • From 2010 – 2011, economy began to recover as vacancy rates declined and net absorption levels became positive again. • The CBD’s overall vacancy decreased by 70 basis points over the past year, falling from 12.3 percent to 11.5 percent. Vacancy decreased by at least 50 basis points across all assets classes, with Class A leading the way with an 80 basis point decrease during the
  • 47. 47 W Chicago Property Market Information Asking Rental Rates The average direct asking rental rate in the CBD currently resides at $36.92 per square foot, an increase from $36.16 per square foot in the third quarter. The average overall asking rental rate increased by 5.43 percent from one year prior. Investment Sales and Deal Activity • 2009 represents a period of low sales activity, however from 2009-2013 there has been a significant growth in the number of sales activity (3 to 31 sales) • Class B offices seems to be frequently traded more than Class A and C • The market remains incredibly hot for sellers, and there is little reason to suspect investment sales activity will slow.
  • 49. 49 W Los Angeles Property Market Information • Net Absorption: The absorption rate is the rate at which available properties are sold in a specific real estate market during a given time period. It is calculated by dividing the total number of available homes by the average number of sales per month. cushmanwakefield.com I 5 MARKETBEAT About Cushman & Wakefield Cushman & Wakefield is a leading global real estate services firm that helps clients transform the way people work, shop, and live. Our 43,000 employees in more than 60 countries help investors and occupiers optimize the value of their real estate by combining our global perspective and deep local knowledge with an impressive platform of real estate solutions. Cushman & Wakefield is among the largest commercial real estate services firms with revenue of $5 billion across core services of agency leasing, asset services, capital markets, facility services (C&W Services), global occupier services, investment & asset management (DTZ Investors), project & development services, tenant representation, and valuation & advisory. To learn more, visit www.cushmanwakefield.com or follow @CushWake on Twitter. Copyright © 2017 Cushman & Wakefield. All rights reserved. The information contained within this report is gathered from multiple sources considered to be reliable. The information may contain errors or omissions and is presented without any warranty or representations as to its accuracy. Greater Los Angeles Office Q1 2017 OFFICE SUBMARKETS Cushman & Wakefield 601 S. Figueroa Street 47th Floor Los Angeles, CA 90017 For more information, contact: Eric Kenas, Market Director, Research Tel: +1 213 955 6446 eric.kenas@cushwake.com Vincent Chang, Senior Analyst Tel: +1 213 955 5125 vincent.chang@cushwake.com Greater Los Angeles Office Q1 2017 Economic Indicators Market Indicators (Overall, All Classes) Overall Net Absorption / Overall Asking Rent 4Q TRAILING AVERAGE Q1 16 Q1 17 12-Month Forecast Los Angeles Employment 4.36M 4.44M Los Angeles Unemployment 5.6% 4.9% U.S. Unemployment 4.9% 4.8% Q1 16 Q1 17 12-Month Forecast Vacancy 14.4% 14.4% YTD Net Absorption (SF) 1.4M 232K Under Construction (SF) 1.8M 2.4M Average Asking Rent* $2.84 $3.13 *Rental rates reflect gross asking $PSF/MO Economy U.S. job growth trend remains firmly in place and nonfarm payroll employment has now increased for 78 consecutive months. Employment growth in the first quarter of 2017 was solid—averaging 178,000 jobs per month. The unemployment rate in Los Angeles County reached its lowest level in 10 years, declining to 4.8% in February. In the last year, nonfarm employment grew by 70,800, or +1.6%. Education and health services listed the largest employment gains, adding 31,300 jobs. The only sector with a reduction in jobs was manufacturing, influenced primarily by the increasing weakness in the apparel industry. Unemployment is expected to decline slowly over the next two years as the county reaches full employment in 2018. Market Overview First quarter leasing activity of 2.7 million square feet (MSF) fell short of the 3.5 MSF quarterly average in 2016. Activity was largely concentrated in LA West with over 1.0 MSF of new leasing and also making up more than half of the top key transactions. Net absorption was positive for the 14th consecutive quarter, but due to major construction completions in each of the past four quarters, overall vacancy remained relatively flat year-over-year (YOY) at 14.4%. New high-end product catering to the rapidly evolving tenant demands has helped push overall average asking rental rates to $3.13 per square foot per month (PSF/MO), for an increase of 10.2% from a year ago. This was the first time since 2008 that there has been such a vigorous YOY increase in average asking rental rates. Most of this rent growth was attributed to submarkets outside of the CBD. LA Metro (non-CBD) overall average asking rents have increased by over +9% YOY, whereas in the CBD they’ve increased by +4.6%. In a sign of increased demand within the CBD, prominent tenants are moving into the market and some CBD landlords are now asking as high as almost $5.00 PSF/MO for premium space. Investment sales volume by SF outpaced first quarter 2016 by +14%, reaching 4.1 MSF. With 1.4 MSF or 34% of the transactions occurring in TriCities, specifically the highest volume in Glendale. There are 3.4 MSF of office developments in the Greater LA construction pipeline, with LOS ANGELES COUNTY $2.25 $2.50 $2.75 $3.00 $3.25 -500 0 500 1,000 1,500 2012 2013 2014 2015 2016 2017 Net Absorption, KSF Asking Rent, $ PSF cushmanwakefield.com I 1 Overall Vacancy increase of 10.2% from a year ago. This was the first time since 2008 that there has been such a vigorous YOY increase in average asking rental rates. Most of this rent growth was attributed to submarkets outside of the CBD. LA Metro (non-CBD) overall average asking rents have increased by over +9% YOY, whereas in the CBD they’ve increased by +4.6%. In a sign of increased demand within the CBD, prominent tenants are moving into the market and some CBD landlords are now asking as high as almost $5.00 PSF/MO for premium space. Investment sales volume by SF outpaced first quarter 2016 by +14%, reaching 4.1 MSF. With 1.4 MSF or 34% of the transactions occurring in TriCities, specifically the highest volume in Glendale. There are 3.4 MSF of office developments in the Greater LA construction pipeline, with nearly 2.0 MSF delivering by the end of 2017. Outlook The office sector is evolving as the definition of creative space broadens and new tech innovations shape up the modern day workplace. These new requirements are impacting nearly every submarket in Greater LA. Office demand is driven by the labor market, and as we approach full employment leasing should remain robust and continued rent growth is expected. In 2017, new office supply catering to these demands may cause vacancy to decline at a more tepid pace. Los Angeles is at the top of list as an investment target market nationally and sales volume is anticipated to exceed 2016 levels and with higher per square foot prices. $2.25 $2.50 $2.75 $3.00 -500 0 500 1,000 2012 2013 2014 2015 2016 2017 Net Absorption, KSF Asking Rent, $ PSF 10% 12% 14% 16% 18% 20% 2012 2013 2014 2015 2016 2017 5-Year Historical Average = 16.6% MARKETBEAT Greater Los Angeles Office Q1 2017 MARKET TOTAL BUILDINGS INVENTORY (SF) DIRECT VACANCY RATE OVERALL VACANCY RATE YTD LEASING ACTIVITY (SF) YTD OVERALL NET ABSORPTION (SF) UNDER CONSTRUCTION (SF) OVERALL AVERAGE ASKING RENT (ALL CLASSES)* DIRECT AVERAGE ASKING RENT (CLASS A)* Los Angeles CBD 54 27,218,777 19.1% 19.9% 253,089 17,749 356,141 $3.42 $3.49 Los Angeles Central (Non-CBD) 140 20,315,970 14.3% 14.3% 128,374 378,046 334,201 $2.63 $2.75 Los Angeles West 416 52,797,801 11.3% 12.3% 1,011,384 (465,863) 1,171,175 $4.51 $4.64 Los Angeles North 407 31,332,528 10.6% 11.0% 506,752 36,897 355,000 $2.40 $2.50 Los Angeles South 249 30,182,254 15.5% 16.1% 447,561 349,126 159,087 $2.35 $2.68 TriCities 195 24,265,956 12.9% 13.8% 196,036 107,111 0 $2.96 $2.96 San Gabriel Valley 170 12,596,238 16.2% 16.5% 161,009 (190,860) 0 $2.15 $2.33 GREATER LOS ANGELES TOTALS 1,631 198,709,524 13.7% 14.4% 2,704,205 232,206 2,375,604 $3.13 $3.47 *Rental rates reflect gross asking $PSF/MO ngeles tely as overall vacancy rates is point (BP) decrease YOY. ince this time last year, R). Class A direct asking rents g by $0.06 PSF/MO to $3.49 YR). First quarter leasing activity terly average. Increased rket close four of the top five nference and event hosting at Wells Fargo North Tower. ifornia took space in Bunker Hill ly. Overall net absorption was saw some intra-market ions or new tenant migration. mmands the highest asking ongest rent growth. Over the ased by +12.8% for all classes wth was in Playa Vista and at $5.25 PSF/MO and $4.91 een a growth in inventory as e first quarter; with more to d is strong as leasing volume over +7% higher than the completions in 2017 will bolster rly for Class A product. ains to be seen if the market will supply delivering in 2017. ties as direct vacancy rates Direct Rental vs. Vacancy Rate CENTRAL BUSINESS DISTRICT Direct Rental vs. Vacancy Rate TRICITIES $2.92 $2.94 $3.19 $3.22 $3.37 $3.44 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% $0.00 $1.00 $2.00 $3.00 $4.00 2012 2013 2014 2015 2016 Q1 2017 PSF/YR DIRECT GROSS RENTAL RATE DIRECT VACANCY RATE Direct Rental vs. Vacancy Rate LOS ANGELES WEST $3.34 $3.43 $3.64 $4.01 $4.33 $4.55 0.0% 5.0% 10.0% 15.0% 20.0% $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 2012 2013 2014 2015 2016 Q1 2017 PSF/MO DIRECT GROSS RENTAL RATE DIRECT VACANCY RATE
  • 50. 50 W Los Angeles Property Market Information • Education and Unemployment • The highest unemployment rates, in both the City of Los Angeles and Los Angeles County, exist for individuals with an educational attainment of high school or less (Exhibit E-6). • Residents with a Bachelor’s degree or higher had an unemployment rate of 5.9 percent in the County (7.0 percent in the City) in 2013, roughly half the rate experienced by those at the opposite end of the spectrum—less than a high school education and high school diploma or equivalent reported unemployment rates of 10.1 percent usually face challenges such as higher unemployment and poverty and will there higher levels of public services and resources. The city and county both have a large proportio resident population with low levels of ed attainment (Exhibit E-5). Almost 25 percen population has less than a high school educa high school graduates (or equivalent) accoun additional 20 percent. As an increased numbe require higher skill levels, a shortage of individ higher levels of education can result in fewer p for their employment, and consequently higher unemployment. Education and Unemployment The highest unemployment rates, in both the Ci Angeles and Los Angeles County, exist for in with an educational attainment of high schoo (Exhibit E-6). Residents with a Bachelor’s degree or higher unemployment rate of 5.9 percent in the Cou percent in the City) in 2013, roughly half experienced by those at the opposite end spectrum—less than a high school education school diploma or equivalent reported unemp rates of 10.1 percent (9.6 percent) and 10.8 (11.6 percent) respectively. Less than HS 23.1% Less than HS 25.4% HS or equivalent 20.4% HS or equivalent 19.4% Some College 19.4% Some College 17.9% Associates 7.0% Associates 6.0% Bachelor's 19.7% Bachelor's 20.9% Masters 6.8% Masters 6.6% PhD or Prof'l 3.6% PhD or Prof'l 3.9% LA County City of LA Population 25 years and over City of LA: 2.6 million Source: 2013 ACS 1-year estimates 8.6% 9.2% 10.1% 9.6% 10.8% 11.6% 9.2% 10.0% 5.9% 7.0% LA County City of LA Exhibit E-6 Civilian Unemployment Rate by Educational Attainment 2013 Population 25 to 64 years Less than High School High School or equiv Some college or Associate's Bachelor's or higher Source: 2013 ACS 1-year estimates Executive Summary Exhibit E-12 Industry Employment Growth 2014-2019 in Los Angeles Annual Average % Δ Employment Em Em Co ec Lo an Fr re tro th re Th an th pe wh 6.2 Re oc int lab Mo po Ho Re ma Ind to re 8.7% 7.5% 8.3% 6.2% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Exhibit E-10 Unemployment Rate City of LA California LA County United States Sources: CA EDD, BLS 3.4 3.6 3.8 4.0 4.2 4.4 4.6 2007 2010 20132014 '15f '16f '17f '18f '19f Exhibit E-11 Nonfarm Employment in Los Angeles County (millions of jobs) Sources: CA EDD; Moody's Analytics; LAEDC Lost jobs are recovered by 2015
  • 51. 51 W Los Angeles Property Market Information • Employment, Industries and Jobs • Los Angeles County was hard hit during the recession, and has experienced a slow and anaemic recovery. From an employment base of 4.2 million at the pre- recession peak in December 2007 to a post-recession trough of 3.9 million, the county saw a loss of more than 330,000 jobs, and an unemployment • an unemployment rate consistently 10 percent above the county average, standing currently at 8.7 percent—both are above the state rate of 7.5 percent, which is also above the national rate, which stood at 6.2 percent in 2014. • Most industry sectors will follow this general contour of post- recession recovery followed by moderation. However, there are differences among industries. Recovery strength in many cases is determined by the magnitude of the industry’s decline during the recession. Industries where employment fell steeply are expected to experience stronger than average growth as they recover from these deep losses. • Recovery of all jobs lost during the recession did not occur until 2015 (Exhibit E-11). Still, this does not take into account the job growth needed to accommodate labour force growth. • The expected employment growth in individual sectors at the county level is shown in Exhibit E-12. While these growth rates are expected to apply at the city level as well, the projected job creation will differ given the different mix of industries in the two regions. • Between 2014 and 2019, the economy is expected to add 322,000 new jobs in nonfarm industries across Los Angeles County, and 126,000 new jobs in the Exhibit E-12 Industry Employment Growth 2014-2019 in Los Angeles Annual Average % Growth Δ Employment (000s) Total Nonfarm Payroll Employment 1.5% 322.0 Good Producing Industries: 0.5% 12.4 Natural Resources and Mining (1.4%) -0.3 Construction 1.8% 11.9 Manufacturing – Durable Goods 0.1% 2.1 Manufacturing – Nondurable Goods (0.0%) -1.2 Service Providing Industries 1.8% 287.6 Wholesale Trade 0.8% 8.6 Retail Trade 0.7% 14.7 Transportation, Warehousing, Utilities 0.7% 5.5 Employment, Industries and Jobs Employment opportunities for residents of Los Angeles County will depend on the health of the regional economy. Los Angeles County was hard hit during the recession, and has experienced a slow and anemic recovery. From an employment base of 4.2 million at the pre- recession peak in December 2007 to a post-recession trough of 3.9 million, the county saw a loss of more than 330,000 jobs, and an unemployment rate reaching a high of 12.6 percent (Exhibit E-10). The City of Los Angeles fared somewhat worse, with an unemployment rate consistently 10 percent above the county average, standing currently at 8.7 percent—both are above the state rate of 7.5 percent, which is also above the national rate, which stood at 6.2 percent in 2014. Recovery of all jobs lost during the recession did not occur until 2015 (Exhibit E-11). Still, this does not take into account the job growth needed to accommodate labor force growth. Most industry sectors will follow this general contour of post-recession recovery followed by moderation. However, there are differences among industries. Recovery strength in many cases is determined by the magnitude of the industry’s decline during the recession. Industries where employment fell steeply are expected to experience stronger than average growth as they recover from these deep losses. The expected employment growth in individual sectors at the county level is shown in Exhibit E-12. While these growth rates are expected to apply at the city level as well, the projected job creation will differ given the different mix of industries in the two regions. Between 2014 and 2019, the economy is expected to add 322,000 new jobs in nonfarm industries across Los Angeles County, and 126,000 new jobs in the City of Los Angeles. 8.7% 7.5% 8.3% 6.2% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Exhibit E-10 Unemployment Rate City of LA California LA County United States Sources: CA EDD, BLS 3.4 3.6 3.8 4.0 4.2 4.4 4.6 2007 2010 20132014 '15f '16f '17f '18f '19f Exhibit E-11 Nonfarm Employment in Los Angeles County (millions of jobs) Sources: CA EDD; Moody's Analytics; LAEDC Lost jobs are recovered by 2015 iv Exhibit E-12 Industry Employment Growth 2014-2019 in Los Angeles Annual Average % Growth Δ Employment (000s) Total Nonfarm Payroll Employment 1.5% 322.0 Good Producing Industries: 0.5% 12.4 Natural Resources and Mining (1.4%) -0.3 Construction 1.8% 11.9 Manufacturing – Durable Goods 0.1% 2.1 Manufacturing – Nondurable Goods (0.0%) -1.2 Service Providing Industries 1.8% 287.6 Wholesale Trade 0.8% 8.6 Retail Trade 0.7% 14.7 Transportation, Warehousing, Utilities 0.7% 5.5 Information 1.4% 14.7 Financial Activities 1.2% 13.1 Professional and Business Services 2.1% 67.8 Educational and Health Services 2.7% 105.6 Leisure and Hospitality 2.3% 54.7 Other Services 0.5% 4.0 Government 0.8% 20.6 Sources: California Employment Development Department; LAEDC The C an une the c percen which 6.2 pe Recove occur into a labor f Most i post-re Howev Recove magni Indust to exp recove The ex at the growth well, t differe Betwe 322,00 Angele Angele 3.4 3.6 3.8 4.0 4.2 4.4 4.6 2007 2010 20132014 '15f '16f '17f '18f '19f Exhibit E-11 Nonfarm Employment in Los Angeles County (millions of jobs) Sources: CA EDD; Moody's Analytics; LAEDC Lost jobs are recovered by 2015
  • 52. 52 Los Angeles Property Market Information Executive Summary Los Angeles: People, Industry and Jobs 2014-2019 Exhibit E-13 Occupational Growth in Los Angeles County 2014-2019 (Δ Employment) SOC Occupational Group New Jobs Replace- ment Total * 11-0000 Management occupations 14,130 25,810 39,940 13-0000 Business and financial 13,440 23,520 36,960 15-0000 Computer and mathematical 8,100 7,740 15,840 17-0000 Architecture and engineering 2,790 7,790 10,580 19-0000 Life, physical, social science 2,130 5,210 7,330 21-0000 Community and social services 9,200 8,060 17,260 23-0000 Legal occupations 1,960 3,720 5,680 25-0000 Education, training and library 13,030 22,510 35,540 27-0000 Arts, entertainment, sports 6,110 18,850 24,960 29-0000 Healthcare practitioners 26,720 20,230 46,950 31-0000 Healthcare support 16,500 9,180 25,680 33-0000 Protective services 10,500 13,400 23,900 35-0000 Food preparation and serving 45,210 63,460 108,670 37-0000 Building/grounds maintenance 17,300 13,400 30,700 39-0000 Personal care and service 20,850 18,610 39,460 41-0000 Sales and related 20,480 62,990 83,470 43-0000 Office and administrative 50,090 74,190 124,280 45-0000 Farming, fishing and forestry 130 730 860 47-0000 Construction and extraction 9,920 8,830 18,750 49-0000 Installation, maint / repair 6,530 13,160 19,690 51-0000 Production 7,940 24,190 32,030 53-0000 Transportation/material moving 15,960 34,530 50,490 Total* 322,000 480,000 802,000 * May not sum due to rounding Source: Estimates by LAEDC Less than HS 33.9% HS, no exp 29.0% HS, some exp 5.9% Postsecondary non-degree award 5.3% Associate's 4.4% Bachelor's, no exp 11.3% Bachelor's, some exp 5.2% Master's 1.6% Doctoral or professional degree 2.2% Exhibit E-14 Entry Level Education and Experience Requirements Source: Estimates by LAEDC
  • 53. 53 W San Diego Property Market Information • The effect of the GFC caused construction of office buildings to lessen, due to the fact that less offices were being demanded, and so the supply overweighed the demand. • From 2006 – 2008, Net absorption trended downwards whilst vacancy rates increased. In addition, the number of offices constructed began to lessen from the onset of the GFC. • From 2009 onwards, vacancy rates have decreased, whilst net absorption gradually increased.
  • 54. 54 W San Diego Property Market Information • Construction activity has exceeded 1.5 million SF and by year-end, will be at its highest level since 2008. With only 551,349 SF currently under construction, there is no concern for over- building as was the case prior to the recession that began in 2007. Additionally, demand since 2014 remains as strong – if not stronger – than most of the years prior to the recession.
  • 55. 55 San Diego Property Market Information • California and San Diego economy showing signs of improvement • Housing market strengthening • Unemployment declining • But employment conditions still difficult for many • Considerations for LMI workers • Fewer mid‐wage jobs, more low‐wage jobs • Most low‐wage jobs don’t pay living wages • Increasing importance of educational attainment U.S.GDPgrowth0.4%forQ42012 ‐10 ‐8 ‐6 ‐4 ‐2 0 2 4 6 20052006200720082009201020112012 Percent Change Percent Change in Real GDP, 2005‐2012 Source: Bureau of Economic Analysis 4thQ 2008: TARP 1stQ 2009: ARRA Californiamortgagedelinquenciescontinuetofall 0 200,000 400,000 600,000 800,000 20052006200720082009201020112012 Number of Mortgages Loans in ForeclosureAll Mortgages Past Due Source: Mortgage Bankers Association, National Delinquency Survey CaliforniaandNevadahavethehighest unemploymentamong12thDistrictstates 11.8 10.8 8.9 8.4 8.4 7.1 7.5 6.2 5.9 9.6 9.6 8.4 7.9 7.5 6.5 6.2 5.2 5.2  ‐  2  4  6  8  10  12  14 NVCAORAZWAAKIDHIUT Unemployment Rate (seasonally adjusted) Unemployment Rates in the 12th District Feb. 2012Feb. 2013 U.S. (Feb. 2013) ‐7.7% Source: Bureau of Labor Statistics
  • 56. 56 San Diego Property Market Information Californialaborforcecontinuestogrow, employmentrecovering 14 15 16 17 18 19 20032004200520062007200820092010201120122013 Individual Workers (in millions) Labor Force and Employment in California, 2003‐2013 Labor Force Employment Source: Bureau of Labor Statistics Californiahasaddedjobsforthelastseveral quarters,SanDiegojobgrowthonpace ‐8% ‐6% ‐4% ‐2% 0% 2% 4% 200120022003200420052006200720082009201020112012 Employment (Year‐over‐Year Growth) CALASD Source: Bureau of Labor Statistics (quarterly data through end of 2012) SanDiegoemploymentcontinuestogrow 1,140 1,160 1,180 1,200 1,220 1,240 1,260 1,280 1,300 1,320 1,340 2003200420052006200720082009201020112012201 Total Nonfarm Employment (in thousands) Total Nonfarm Employment (in thousands) 2003‐2013 San Diego‐Carlsbad‐San Marcos  Recession Source: Bureau of Labor Statistics, not seasonally adjusted Source: National Employment Law Project ‐21% ‐60% ‐19% 58% 22% 20% ‐80%‐60%‐40%‐20%0%20%40%60%80% Lower Wage Mid Wage Higher Wage Jobs Lost in the RecessionJobs Gained in the Recovery Growthinlowerwagework Source: National Employment Law Project ‐21% ‐60% ‐19% 58% 22% 20% ‐80%‐60%‐40%‐20%0%20%40%60%80% Lower Wage Mid Wage Higher Wage Jobs Lost in the RecessionJobs Gained in the Recovery Growthinlowerwagework
  • 57. 5757 57 APPENDIX DIVISION 2 – STRATEGIC RESEARCH 57
  • 58. 5858 58 SUBDIVISION 1 – LEGAL & GEOGRAPHIC RESEARCH 58
  • 59. 59 W Due Diligence Checklist Property and Local Market Conditions 1. Property type and physical condition / quality 2. Property location and competitive position 3. Property cash flows over the loan period 4. Property values (today, at maturity, at stabilization, in liquidation and recovery) 4. Rent rolls 5. Capital needs 6. Tenant defaults and payment delays, retention and renewals 8. Significance of personal property 9. Local market and sub market conditions Borrower Capabilities and Motivation 1. Borrower/sponsor financial and managerial strength 2. Extent of distress on borrower’s other properties / businesses 3. Borrower’s exposure on guarantees (contingent, full repayment, completion, or loss recovery) 4. Borrower’s tax position 5. Borrower’s reliance on management fee revenue (property, asset management, etc.) 6. The ownership entity’s control, capital structure, and approval processes These factors are essential as they influence the borrower’s behaviour and negotiating strategy. It can vary from obtaining a release from personal guarantees (DIL), maintaining control of the property to protect or to participate in its potential upside recovery, preserving management fee revenues, contributing and getting credit for ‘new’ money, pursuing bankruptcy or lender liability actions, and / or managing tax consequences and timing. Legal Structures and Documents Loan documents and key terms such as interest rates, maturities, escrows, and lock boxes Mortgages, assignments and other security Guarantees Additional collateral Other credit support Development and management agreements Lender recognition of agreements including leases Assignments of rents and receivables Lender lock box arrangements for collection of rents Default events, rights, and remedies Lender rights, obligations, and exposure under documents Other Creditors Construction trade claims Mechanics liens Other mezzanine debts Inter-creditor agreements Other secured or unsecured debt Servicing History Review of the loan servicing history and files can be used to develop pricing assumptions. Servicing files can be used to help indicate whether the property or borrower has supported the debt. Servicing and payment history and sources Servicing and correspondence Existence and status of any defaults Correspondence to/from borrower Financial analysis of borrower and guarantors Availability of assets to satisfy guarantees
  • 60. 60 W Legal Background Mezzanine financing tends to be highly negotiated and customised for the particular situation. Type of Instrument MF typically consist of unsecured or second lien debt, or less frequently, preferred stock. In practice, most mezzanine financing, particularly for larger financings, takes the form of subordinated, unsecured debt. Initial structuring discussions often focus on whether the debt should be in the form of loans or debt securities, with the investors' view of the likely resale market (bank or bond) driving the result. MF in the form of debt often includes equity participation, in the form of warrants, options and/or conversion features or co-investment rights associated with the primary mezzanine investment. Covenants Key negative covenants in mezzanine debt may include limitations on: Incurrence of debt. Restricted payments (including dividends, repurchases of equity and junior debt, and certain types of investments). Liens. Change of control transactions. Asset sales. Affiliate transactions. Affirmative covenants may include those relating to: Financial reporting. Maintenance of insurance. ERISA compliance. Equity Participation Mazanine investors regularly seek to enhance their returns by negotiating for equity participation alongside debt investments. This can take various forms: Warrants or options to purchase a specified percentage of equity (1-5% usually) Right to co-invest in the issuer alongside the controlling stockholder or a PE sponsor. Purchased equity would usually be bound by the terms of any stockholders’ agreement or other arrangement among other stockholders. Conversion feature that allows mezzanine investors to convert all or a portion of their principal investment into common equity of the issuer.
  • 61. 61 W Legal Background Inter-creditor Relationships Senior debt holders have ability to suspend payments to mezzanine debtholders for up to 179 days in cases of default. While precedents vary, in cases where mezzanine investors will receive only limited equity interests in the issuer, ordinarily they have limited leverage to negotiate for more than standard tag-along rights and registration rights, as well as customary anti-dilution protections. In cases where mezzanine investors are also taking larger equity stakes, however, they may also negotiate for veto rights for specified corporate actions including equity offerings, mergers, affiliate transactions or changes in senior management. Mezzanine borrower typically only owns limited liability interests in a limited liability company Addition of a mezzanine loan to the borrowing structure can bring the total loan-to-value ratio of a transaction to 90-95%. Limitations on Rights and Remedies under Intercreditor Agreements Mezz loans are typically contractually subordinated to the related senior mortgage loans pursuant to the terms of an Intercreditor agreement entered into between the senior mortgage lender and mezzanine lender. These agreements severely limit and restrict the ability of mezz lenders to enforce their rights and remedies under the mezz loan documents. Commercial Mortgage Securities Association (CMSA) have developed model forms that have become the industry norm on the content and coverage of these Intercreditor agreements. The agreements limit the mezz lender’s ability to control Equity Interest and to establish indirect control of the underlying real estate and to make certain decisions and take certain actions without the senior mortgage lender’s consent. The Intercreditor agreement typically requires borrower to obtain a ‘no downgrade letter’, which provides confirmation from rating agencies that mezz lender’s enforcement actions will not cause a downgrade of the rating of the related CMBS issurance which is secured. The Intercreditor agreements also place strict limitations on the identity of the mezzanine lender since it may succeed to the indirect ownership of the underlying mortgage borrower and therefore end up being the owner and operator of the land serving as collateral for the mortgage. The only ability of the mezzanine lender to escape the confines of the senior morgtage is to buy out the senior lender. If there is a default under the senior mortgage loan, most Intercreditor agreements grant the mezz lender to purchase the senior mortgage loan. Even if the mezzanine lender is able to obtain control of the mortgage borrower, its rights remain very limited not only because of the restrictions in the Intercreditor agreement, but also because the mezzanine lender (in its new capacity as mortgage borrower) is still subject to the senior mortgage covenants and restrictions.
  • 62. 62 W Legal Background Inter-creditor Relationships The senior mortgage typically contains many limitations on the ability to sell the property, make major improvements to the property, change control of the property, or undertake other major decisions without the senior mortgage lender’s consent. The only option available is to refinance the property or to buy out the senior lender at par. Mezz lenders are further restricted since they rarely succeed to the benefits from certain third-party agreements such as ground leases, subordination and non-disturbance agreements, etc. The mezz lender is under time pressure and must realise upon its collateral and exercise its remedies prior to the senior mortgage lender completing a foreclosure on the underlying mortgage. Once the senior mortgage lender completes its foreclosure, the underlying mortgage borrower will no longer own the income producing property and the mezz borrower will own equity in an entity with no assets. In the case the underlying mortgage borrower sells the property, the mezz lender’s only action against the mezz borrower is for a breach of the contractual promise not to sell. Compared to the senior mortgage lender’s right to foreclose its senior mortgage, the mezz lender’s right to foreclose on the Equity Interests of the mezzanine borrower is riskier and of limited value. Upon default, the mezz lender’s remedies derive solely from its lien on personal property (i.e. the equity in the mezz borrower). This means the mezz lender has no rights to foreclose any other liens on the underlying real property, its rights are limited solely to foreclosing junior liens on the equity in the mezzanine borrower and not the real property. What this means is that even after a successful foreclosure of a mezzanine loan, the underlying mortgage property remains subject to the lien of the senior mortgage as well as any other liabilities, liens, leases and other encumbrances of the underlying mortgage borrower and the underlying real property. Meaning the mezz owner will only indirectly own the underlying mortgaged property
  • 63. 63 W Legal Background Debt to Equity Swap In the case of Nine Entertainment, they were able to avoid bankruptcy in 2012 after warring lenders agreed on a A$3.3bn debt-for-equity swap that hands control of Channel 9 to two investment groups. Apollo Global Management and Oaktree Capital, which owned about 40% of Nine’s 2.3bn senior debt, offered Goldman Sachs (second-tier lenders) a bigger equity stake in a recapitalised and debt-free Nine (7.5%). In return, Goldman Sachs dropped its demand for warrants in the restructured company. This was subsequent to Goldman Sachs’ original proposal of swapping the mezz debt for 30% equity in Nine. Debt to equity swaps (restructure) from the junior (mezzanine) lender is subject to the senior lender’s approval. However, at the same time, if valuation provides that ‘the value of the company breaks into the mezzanine debt’, aka, the junior lender has an economic interest in the business, the restructure requires consent of the junior lender. This effectively means the mezzanine debt holder also has a leverage against the senior debt owner by barring their ability to restructure their capital structure. Debt to Equity Swap was done by Goldman Sachs and Park Square to take control of Northgate, from owner KKR. This was backed with a 320m leveraged loan financing. Mezzanine Lender’s Leverage against Senior Debt Holder It is arguable that if the senior lenders are able to convince a court that the junior lenders’ debt is out of the money. High Court Justice of England and Wales’ judgment of Bluebrook Ltd in 2009 It was determined that if they had an economic interest, they must be consulted in a Scheme of Arrangements and they must give consent.
  • 64. 64 Outlining population movement in Chicago – Phone Tracking Analysis Overview Using geographic data from twitter, we are able to map out where people congregate in urban centers. • This provides important socio-economic information - as iPhone users earn, on average, 40% more than Android users • This data shows that West Loop (as outlined by the white box) is subject to more foot traffic by higher net wealth individuals than inland Chicago • We can infer that this means that the process of gentrification is nearly complete, establishing long-term demand for real estate and commerce 64
  • 65. 65 Outlining population movement in San Diego– Phone Tracking Overview • From the data, it is clear that iPhone users congregate in the Downtown region • This allows us to infer that there is a high concentration of higher-wealth individuals passing through this area 65
  • 66. 66 Outlining population movement in Los Angeles– Phone Tracking Overview • This map indicates that while Android users are distributed evenly across LA, iPhone user tend to cluster in areas such as the Downtown region • This is indicative of the socio-economic division in LA • It also spotlights the defensibility of the LA office market 66
  • 67. 6767 67 SUBDIVISION 2 – PRECEDENT & SUPPORTIVE TRANSACTIONS
  • 68. 68 W Precedent & Supportive Transactions 2009: Blackstone- purchasing at discount • Blackstone helped Hilton Worldwide restructure substantially all its debt by the purchase and retirement of $1.8 billion debt and the conversion of $2.1 billion of junior mezzanine debt to preferred equity • Blackstone borrowed $13 billion and agreed to take on $7 billion of Hilton’s existing debt. • Blackstone offered to buy back some of the bank debt at a discount • Blackstone negotiated its equity stake in Hilton to 70%
  • 69. 69 W Precedent & Supportive Transactions 2008: Apollo Real Estate Advisors (AREA) – Loan to Own • Africa-Israel Investments and Mann Realty were owners to the Apthorp apartment. • Condo conversion was unsuccessful • Foreshadowing a default, their $135 million mezzanine debt lender AREA and first mortgage lender Anglo Irish Bank threatened to foreclose on the deal. • Owners forced to come up with $23 million in additional equity which lead to the lenders controlling the property and ultimately replacing Mann’s manager
  • 70. 70 W Precedent & Supportive Transactions 2007: Icahn Enterprises – purchasing at a discount - Stratosphere resort was a hotel-casino in Las Vegas facing bankruptcy in 1997 - Icahn purchased Stratosphere’s debt for under 10 cents on the dollar pennies on the dollar and eventually also bought out the minority shareholders for $82 million. - In 2007 Icahn sold the Stratosphere along with neighbouring properties for $1.3 billion.
  • 71. 71 W Precedent & Supportive Transactions 2009: Apollo Management and Oaktree Capital – Loan to Own - Countrywide was UK’s largest estate agency. - In 2007, weighed down by the housing market, it was unable to support its debt load in the long- term - In 2008, Oaktree began purchasing Countrywide’s bonds, up to 34% in the company’s secured bonds. - In 2009, Apollo negotiated with bondholders to discuss a potential debt restructuring and successfully recapitalised the company
  • 72. 72 W Bryant Plaza Research Renovation #1: Underground carparking (WIP Leadership Board Member Michelle Wendler, AIA, is Principal of Watry Design. She has been creating parking solutions for the firm’s clients for more than 24 years. Wendler, a licensed architect in 12 states, is responsible for the design) Assumptions: (Assumptions made from Michelle Wendler, the lead parking designer and structure for Watry Design and a licensed architect in 12 states, is responsible for the design of more than 150 parking projects) The property’s on-site parking of 300 spaces is on land and not part of the building Soil condition of property is suitable and allows for underground car park construction $5000 annum revenue/ stall 135 sf width and length 300-340 sf/ stall $45/sf Plan: Additional 400 spaces as underground parking, this will bring additional $2M/annum Construct 4 underground car parking levels to add 400 parking spots Cost of construction: Average size of car park: 320 sf No. car parks: 400 Price per sf: $450-$550 320sf*400=12,800*45= $5.7M NOI: Car park rent flat rate: $10 No. days per year: 265 No. car parks: 400 $10*365*400= $1.5M Things to consider: Geography: LA Average costs of labor and resources needs to be noted. As well as condition of soil, seismic regions and availability of materials.
  • 73. 73 W Bryant Plaza Research • Number of parking levels: • In general, a larger-footprint parking structure that is shorter will cost less per parking space than a taller structure with a smaller footprint. The cost per square foot of the first level that is on the ground is less than levels that are elevated above the ground. A lower-height, larger-footprint structure will have a higher proportion of the cost in the first level. The taller a structure is the heavier it is, and this affects the foundation cost. A taller structure generally has a less efficient parking layout, which translates into more square feet for each parking space. • • Cost of underground parking: • If a parking structure is one level underground, the cost per square foot can increase by approximately 15%. If the structure is more than one level below the ground, the cost would be approximately 45% higher than the original cost per square foot as cost increases due to impacts of having to dig deeper. • Cost of structural system: • 60% to 70% of the cost of parking is in the structural system. Therefore, the selection of the framing system will have a significant effect on the cost of each parking space. There are two general types of framing layouts and there are different types of structural systems. The two types of framing layouts are short- span and long-span. Short span is where you have a column approximately every three parking spaces (27x30 feet square) to support the floor slab. Long-span is where you have columns spaced 60 feet apart, with beams spanning over the stalls and the drive aisle. Generally, short-span systems cost less per square foot, but the efficiency is not as good. Long-span systems cost more per square foot, but you are getting more stalls in the same square footage. The structural system of a parking structure can be either Cast-in-Place Concrete, Precast Concrete or Structural Steel. Which system is more cost effective depends on the location of the project and the preferred methods of construction in the region. This is a case-by-case analysis. The selection of a system that is not common in the area will generally cause the structure to cost more. • • The foundation system of the car park has a huge impact on cost of structured car parks. • Structures founded in poor soils’ conditions that require more expensive, deeper foundation systems will cost more. The difference between a shallow and deep foundation system can increase the price approximately 10% overall – taking the cost from, say, $50 to $55 per square foot.
  • 74. 74 W Bryant Plaza Research Total car parking spaces The overall size of a project has an effect on the cost per parking space. A smaller project will cost more per space than a larger project. A 200-stall parking structure on a small site may cost about 30% more per square foot than a 1,000-stall structure on a “reasonably” sized lot. Efficiency This is the amount of square footage it takes for every parking stall overall. The cost of a parking space is the cost per square foot times the square foot per parking stall. So, the more square feet you have to build per stall will increase the cost per stall. Market conditions As we have seen over the last few years, the cost of parking can be affected by market conditions. Costs can go both down and up. The swing can be 10% or more. A normal bid market will generate four to six bids from qualified contractors. An aggressive bid market might see 10 or even more bids, some not necessarily from qualified bidders. This will cause the price to decrease but can create concern if the bidders are not qualified. An impacted bid market might see one to three bidders and price increase due to lack of competition.
  • 76. 76 W Bryant Plaza Research Assumptions: (Data from U.S Department of Housing and Urban Development) 6 ft fire code safety setback 7% unusable area of roof due to safety setbacks – minus 1283 sf 15% rooftop obstructions- minus 2750 sf Total usable rooftop area= 18333-1283-2750= 14,300 sf (Quote from US-based professional design services firm ‘Cabaret Design Group’) Average cost to build a bar is $200-$300 per sf Average 18’ 6” bar equipment cost: $8,000 Cost of contstuction: Construction cost per sf: $200-$300 per sf Bar equipment cost: $8,000 Total Cost: ($250*14300)-8000= $360,000 Cost: $300,000-$400,000 NOI: $1.8M
  • 77. 77 Appendix – Cutler Center Renovation Comps Overview - Costings • $800M Costing • 1.2M Sqft renovation • Indicative of $667/sqft Westfield Century Centre Returns Analysis • Occupancy expense proportions imply an annualized increase in rental revenue of 50-80m p.a
  • 78. 78 Appendix – Cutler Center Renovation Comps Overview - Costings • $500M Costing • 400K Sqft renovation • Indicative of $1250/sqft Willis Towers Renovation • Willis Tower’s is the tallest building in Chicago • Purchased by the Blackstone Group • Renovation inclusive of five-star restaurants, casual dining options, a 30,000sqft outdoor deck and 50,000swft ‘digital attraction’ • Significantly more expensive than planned cutler renovations
  • 79. 79 Appendix – Cutler Center Renovation Comps Overview - Costings • $1B overall costings • 3M sqft of retail space • Indicative of $340/sqft Union Station Renovation • Union Station is a major inner- city rail hub • Renovation is inclusive of retail, office and administrative space
  • 80. 80 Appendix – Rivers Towers Renovation Comps Overview - Costings • $7M renovation of facilities • Roughly 24,000 square feet renovated • Implies a cost of $290/sqft 701 B St Renovation • 701 B St is a class A office and entertainment space • Renovation was focused on upgrading the lobby, lifts and other shared spaces
  • 81. 81 Appendix – Rivers Towers Renovation Comps Overview - Costings • $500M costing • 2.5M sqare feet • Implies a cost of $200 per square foor Chicago Old Post Office Renovation • The Chicago Old Post office is a major office space • Renovations inclusive of a brand new lobby and rooftop gardens
  • 82. 82 Appendix – Rivers Towers Renovation Comps Overview - Costings • $500M costing • 2M square feet • Implies a cost of $250 per square foot Moscone Center Renovation • The Moscone Center is a major hotel, office and office space • Renovations inclusive of major aesthetic and functional changes
  • 84. 84 W Macroeconomic Risks • Unemployment rate • Risk: difficulty in finding suitable tenants • Low unemployment rates may affect our occupancy rate and ability to find tenants when leases rollover • We should find a well-diversified mix of tenants for our office buildings when leases end. Selected tenants should be from growing employment rate sectors such as health & education industry and the financial services industry • However, unemployment rates forecasted to peak in 2010 and then fall steadily • Occupancy and rents forecasted to begin sustainable growth in 2011 • 8.7M jobs were lost during the recession but 7.4M jobs were gained by 2014 during recovery. Six subsectors have accounted for 83.4% of recovered jobs. Professional and business services sector accounting for the most percentage of recovered jobs then Health care and Leisure & Hospitality inudstries • • Chicago: • Metro Chicago economic results have proven unsteady. However, CH has recorded year-to- date growth of more than 31,000 jobs compared to losses of 92,000 from the same period of 2009. Unemployment rate forecasted to drop to 8.1% in coming 3 years (2013) • Economy is expected to go into accelerated expansion especially office jobs sector • Projected positive absorption duelled by drop in rate of sublease additions and increased occupancy rates • Office buildings leased to young social media tech companies • Chicago’s CBD leasing market experienced most activity from small to mid-sized users • Many landlords improved and upgraded their properties to stay competitive by investing in lobby renovations or adding outdoor trances • Chicago CBD has a trend of plug-and-play and on-demand suite availabilities • River North tower a $1.3 m.s.f office building sold for $480 p.s.f (record setting p.s.f pricing in 2010)
  • 85. 85 W Macroeconomic Risks LA: Moderate occupancy rate gains Tenants dominated by law firms and financial services tenants Trend of owners increasingly target a more diverse tenant base, including creative and entertainment companies Westside an established home base for media, technology and mobile industries- these industries are expected to see continued growth and will drive new requirements Increase in competition among tenants for “creative” space has led landlords to increase rental rates- interplay between entertainment and high-tech is significant trend Growing demand for office buildings and sustained growth from existing tech tenants Leisure and hospitality experienced a steep decline due to the recession, but added more than 15,700 LA-based jobs since Jan 2010, driven by an increase in discretionary and business spending San Diego: Leisure and hospitality sector posted the greatest employment recovery- adding 7,000 in 2013 Office-using industries such as professional and business services was one of 7 sectors that saw employment gains Also measured growth in construction Downtown submarket heightened activity- growing demand of tenants in tech sector and projected growth in professional services industries Steady leasing market, transaction volume and sales value in 2010 is forecasted to outpace those seen in past years
  • 87. 87 W Tenant Risk Rent Roll quality Refer to credit worthiness, stability and number of tenants Rollover risk refers to remaining term left on leases at a property and it affects both single Delinquency Rate Delinquent loans rising- through 2009 9% of CRE loans in bank portfolios were delinquent, which is more than double of 2008 There has been a significant increase in non-performing commercial real estate in the US since 2008. This period also saw heightened levels of maturities and record levels of outstanding commercial mortgage debt. The total value of distressed commercial real estate was $166.8 billion in 2010, including properties in distress, foreclosure, and lender REO, according to data from Real Capital Analytics Starting June 2010- volume and value of distressed commercial real estate has dropped Delinquency rates has risen steadily over the past two years from 5% in the 4Th quarter of 2007 to 19.0% in first quarter of 2010. Non-accrual rate increased rom 2.9% to 14.6% The commercial mortgage sector’s total delinquency rate grew to 5.5% in the 1st Q of 2010, compared to 5.1% in 4th Q of 2009 and 3.6% one year ago Non-accrual rate is the main factor contributing to coverall growth, accounting for 69% of the total delinquency Bank-held commercial mortgage default rate rose to 4.2% in the 1st quarter 2010 compared to 2.3% the previous year
  • 88. 88 W Tenant Risk Rent growth fastest in CBD Class A offices based on supply and demand coming in close to equilibrium levels
  • 89. 89 W Tenant Risk New supply coming to market is slowly increasing but still well below historic norms New supply coming to market is slowly increasing but still well below historic norms
  • 91. 91 W Financing Risk Interest Rate RIsk  Risk that interest rates will increase when we refinance and get a loan from the bank I Debt to Equity Swap Risk of senior lender not giving approval of debt to equity swaps Debt-for-equity swap significantly de-levers the distressed property’s balance sheet Mezz lender faces the risk of a separate foreclosure on pledged equity interests of the borrowing entity. Inter-creditor agreements creating rights and obligations between lenders can also impact the success of lender’s control of the borrowing entity. A mezz lender in foreclosure can significantly change the loan resolution outcome if the mezz lender has a position that is partly in the money or has the ability to bring new money or expertise to the situation. Inter-creditor agreement assumption- E.g. provide that all cash flow be paid on occurrence of a default, to senior note holders interest and principal until the senior debt is fully repaid before any interest can be paid to subordinate holders Upon a borrower’s default, mezz lender’s only commercial alternative is to cure the default by refinancing the secured property or taking out the senior lender at par value. Average mezzanine loans have a default rate of 16.10%
  • 92. 92 W Competitive & Construction Risk Construction Risk Cost overruns May take longer than anticipated to complete Expose previously unknown defects in the physical asset Default of construction company? During post-recession where manufacturing and construction industry suffered the most Tenant improvements are currently averaging 18% of the first year’s least cost for ‘A’ properties
  • 93. 9393 93 APPENDIX DIVISION 4 – VALUATION 93
  • 94. 94 Property & Mezzanine Overview 94
  • 97. 97 97
  • 99. 99 99